financial analysis of pharmacy …...may 2017 prepared by rsm australia financial analysis of...
TRANSCRIPT
May 2017
Prepared by RSM Australia
FINANCIAL ANALYSIS OF PHARMACY REMUNERATION AND REGULATION
Confidential information has been redacted from this document
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CONTENTS
EXECUTIVE SUMMARY .......................................................................................................................... 5
Data limitations and their implications .............................................................................................. 6
Distributional equity ......................................................................................................................... 6
Economic efficiency ....................................................................................................................... 11
Fiscal sustainability ....................................................................................................................... 13
INTRODUCTION ........................................................................................................................... 14
1.1 Purpose and structure of this report ..................................................................................... 14
1.2 Key sources of financial data ................................................................................................ 15
DISTRIBUTIONAL EQUITY .......................................................................................................... 17
2.1 Equity of access of Australians to affordable medicines ....................................................... 17
2.2 Equity of remuneration arrangements for pharmacies .......................................................... 43
ECONOMIC EFFICIENCY ............................................................................................................ 65
3.1 Consumption efficiency ........................................................................................................ 65
3.2 Production efficiency ............................................................................................................ 71
FISCAL SUSTAINABILITY ........................................................................................................... 78
4.1 Intended fiscal sustainability of current pharmacy remuneration and regulation ................... 78
4.2 Actual economic sustainability of current pharmacy remuneration and regulation ................ 83
4.3 Effects of proposed changes to current arrangements on fiscal sustainability ...................... 84
APPENDICES ........................................................................................................................................ 89
Appendix 1: Number and location of pharmacies and socio-economic status ............................. 90
Appendix 2: Summary of financial data ....................................................................................... 98
Appendix 3: Detailed financials for the different types of pharmacies ........................................ 106
Appendix 4: Benchmarking of micro pharmacies against other comparable businesses ........... 110
Appendix 5: Selected methodologies ........................................................................................ 111
Appendix 6: RPMA case studies ............................................................................................... 129
Appendix 7: Additional information ............................................................................................ 133
Appendix 8: Location of pharmacies and the total PBS remuneration they receive ................... 139
Appendix 9: Wholesale distribution of pharmaceuticals ............................................................. 140
Appendix 10: Glossary ............................................................................................................... 151
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LIST OF FIGURES
Figure 1: Distribution of pharmacies across Australia .......................................................... 20Figure 2: Distribution of pharmacies across regional areas of Sydney ................................ 21Figure 3: Distances that different socio-economic groups have to travel to visit the nearest pharmacy ............................................................................................................................ 22Figure 4: Distances that different socio-economic groups have to travel to visit the nearest pharmacy (broken down by regional areas) ........................................................................ 22Figure 5: Distances that different socio-economic groups have to travel to visit the nearest pharmacy (broken down by regional areas) – magnified distance scale .............................. 23Figure 6: Location of the patient, prescriber and pharmacy ................................................. 25Figure 7: Postage times and shipping charges for medicines purchased from ePharmacy . 27Figure 8: Proportion of scripts that are discounted by remoteness of pharmacy (6 months ended June 2016) ............................................................................................................... 31Figure 9: Frequency distribution of the price paid by general patients in September 2016 for the each of the top 10 medicines – under co-payment scripts ............................................. 35Figure 10: Information required to determine the efficient cost of dispensing ...................... 45Figure 11: Parliamentary Budget Office projections of government pharmaceutical benefit expenditure per script.......................................................................................................... 80Figure 12: Distribution of pharmacies across Victoria and Southern NSW .......................... 90Figure 13: Distribution of pharmacies across Melbourne ..................................................... 91Figure 14: Distribution of pharmacies across Canberra ....................................................... 92Figure 15: Distribution of pharmacies across Darwin .......................................................... 93Figure 16: Distribution of pharmacies across Brisbane ........................................................ 94Figure 17: Distribution of pharmacies across Adelaide ........................................................ 95Figure 18: Distribution of pharmacies across Perth ............................................................. 96Figure 19: Distribution of pharmacies across Hobart ........................................................... 97Figure 20: The relationship between profit and sales mix .................................................... 99Figure 21: Price paid by patient (per pack) for top ten PBS medicine items (ranked by government contribution) in September 2016 for general non-safety patients (over co-payment scripts) ................................................................................................................ 113Figure 22: Boxplots for top ten PBS medicine items (ranked by government contribution) in September 2016 for general non-safety patients (over co-payment scripts) ...................... 114Figure 23: boxplot of price paid by patient (per pack) from top ten PBS medicine items (ranked by script volume) in September 2016 for general non-safety patients from under co-payment scripts ................................................................................................................. 118Figure 24: Pharmacies in Griffith locality (Postcode 2680) ................................................ 129Figure 25: Postcode area 2680 ......................................................................................... 129Figure 26: Pharmacies in Alice Springs locality (Postcode 0870) ...................................... 130Figure 27: Postcode area 0870 ......................................................................................... 130Figure 28: Average remuneration per script by pharmacy ................................................. 133Figure 29: Distribution of the value of high cost medicine sales expressed as a proportion of total PBS sales across pharmacies in different PhARIA .................................................... 134Figure 30: Distribution of proportion of high cost medicine sales across pharmacies in different PhARIA ............................................................................................................... 135Figure 31: Distribution of e-Scripts as a proportion of total scripts by pharmacies in different PhARIA ............................................................................................................................. 136Figure 32: Distribution of percentage of dangerous drug scripts by PhARIA ..................... 137Figure 33: Distribution of pharmacies across regional areas of Sydney and total PBS per pharmacy .......................................................................................................................... 139Figure 34: Distribution of pharmacies across regional areas of Melbourne and total PBS per pharmacy .......................................................................................................................... 139Figure 35: Distribution of CSO pharmaceutical wholesalers across Australia .................... 141Figure 36: Efficiencies gained from direct wholesaling ...................................................... 145
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Figure 37: Full line wholesaler costs for distributing high cost drugs ................................. 147Figure 38: Fiscal savings from price disclosure ................................................................. 150
LIST OF TABLES
Table 1: Location of patient, prescriber and pharmacy, by type of patient ........................... 26Table 2: Illustration of how general patient co-payments for different types of medicines provide the highest nominal rates of assistance to patients of the most expensive medicines ........................................................................................................................................... 29Table 3: Differences in the prices paid by general patients per pack for the top 10 over co-payment medicines (September 2016) ................................................................................ 32Table 4: Illustration of how the quantity of medicines prescribed per script affects the price that patients pay per pack of medicines for over co-payment scripts ................................... 32Table 5: Differences in the prices paid by general patients per pack for the top 10 under co-payment medicines (September 2016) ................................................................................ 34Table 6: Illustration of how the quantity of medicines prescribed per script affects the price that patients pay per pack of medicines for under co-payment scripts ................................. 34Table 7: Effect of price variations on the prices of medicines to patients by location of pharmacy (general under co-payment scripts only) ............................................................. 39Table 8: Effect of price variations* on the prices of medicines to patients by pharmacy size and location (general under co-payment scripts only) ......................................................... 39Table 9: Effect of price variations* on the nominal rates of assistance** provided to patients by pharmacy type and location (general under co-payment scripts only)............................. 40Table 10: Overall combined effect of price variations and the $1 discount on the prices paid by patients by type of patient (2016 calendar year) ............................................................. 41Table 11: Geographic distribution of applications to establish new, and relocate existing, pharmacies (financial year 2015-16) ................................................................................... 42Table 12: Summary of pharmacy financial data available .................................................... 49Table 13: Pharmacy profitability and rates of return on capital ............................................ 52Table 14: Proportion of pharmacies in each category.......................................................... 52Table 15: Illustration of the effect that paying pharmacies the same fee for performing different types of activities has on effective rates of assistance provided to pharmacies ..... 58Table 16: Current effective rates of assistance provided to different types of pharmacies ... 59Table 17: Geographic distribution of micro pharmacies ....................................................... 61Table 18: Effective rates of assistance provided to different types of pharmacies following the introduction of a $10 flat fee for dispensing ................................................................... 63Table 19: Effect of introducing an illustrative $10 flat fee for dispensing on the effective rates of assistance afforded different types of pharmacies ........................................................... 64Table 20: Actual and projected fiscal costs of pharmaceutical benefits and services expenses ............................................................................................................................ 79Table 21: Total PBS expenditure 2015-16 ........................................................................... 81Table 22: Average PBS expenditure per pharmacy 2015-16 ............................................... 81Table 23: Average PBS expenditure per script 2015-16 ...................................................... 82Table 24: Actual and projected economic costs of pharmaceutical benefits and services expenses ............................................................................................................................ 84Table 25: Fiscal and economic cost savings from a $10 flat fee per script .......................... 84Table 26: Average PBS expenditure per script 2015/16 ...................................................... 88Table 27: Summary of financial data available for micro pharmacies ($0 - $2m annual turnover) ........................................................................................................................... 101Table 28: Summary of financial data available for small pharmacies ($2 - $10m annual turnover) ........................................................................................................................... 102Table 29: Summary of financial data available for medium pharmacies ($10 - $20m annual turnover) ........................................................................................................................... 103
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Table 30: Summary of financial data available for large pharmacies ($20 - $40m annual turnover) ........................................................................................................................... 104Table 31: Summary of financial data available for very large pharmacies ($40m and over annual turnover) ................................................................................................................ 105Table 32: Financial summary for profitable and taxable pharmacies ................................. 107Table 33: Financial summary for profitable and non-taxable pharmacies .......................... 108Table 34: Financial summary for non-profitable pharmacies ............................................. 109Table 35: Benchmarking of micro pharmacies against other comparable businesses ....... 110Table 36: RPMA postcode case study: summary of pharmacies within postcodes receiving RPMA ............................................................................................................................... 131Table 37: Total RPMA payments paid to PhARIA 2 to 6 pharmacies for the 2014-15 and 2015-16 financial years ..................................................................................................... 132Table 38: RPMA payment matrix 2016-17 ......................................................................... 132Table 39: Trends in script volumes and PBS revenue for community and hospital pharmacies 2012-13 to 2015-16 ....................................................................................... 138Table 40: Additional fees paid to TGA licensed chemo compounding facilities .................. 138Table 41: Summary of financial information available on pharmaceutical wholesaling ...... 143Table 42: Illustration of how the current wholesaler remuneration arrangements affect the nominal rates of assistance provided to the wholesale distribution of medicines with different prices ................................................................................................................................ 147
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EXECUTIVE SUMMARY
This report presents the key results of the financial analysis of the current pharmacy remuneration
and regulation, as well as the effects of several potential options for reform identified in the Panel’s
Interim Report. The analysis has been conducted in accordance with the statement of requirement
issued by the Department of Health. In cases where the results of the analysis directly related to any
of the options developed by the Panel, they were referenced in the relevant section of the report.
These options include the following:
Option 2.1: Pricing Variations. The payment made by any particular customer for a PBS listed
medicine should be the co-payment set by the government for that customer, or the dispensed
price for that medicine, whichever is the lower. The community pharmacy should have no
discretion to either raise or lower this price;
Option 2.2: $1 Discount. The government should abolish the $1 discount on the PBS patient co-
payment;
Option 2.7: Electronic Prescriptions. The government should initiate an appropriate system for
integrated electronic prescriptions and medicine records as a matter of urgency. Under this
system, the electronic record should become the legal record. Participation in the system should
be required for any prescriber of a PBS listed medicine, pharmacist wishing to dispense a PBS
listed medicine, and any patient who is seeking to fill a PBS prescription;
Option 4.3: Benchmark for an Efficient Dispense. On the basis of the information that has been
made available to the Panel, and given the data limitations, the Panel considers that the current
benchmark for a best practice dispense be within a range of $9.00 to $11.50. This should be
reflected in the average compensation paid to a pharmacy for a dispense; and
Option 5.1: Location Rules – Removal and Replacement. The government should remove the
location rules for community pharmacies. It should replace the location rules with one of the
alternatives presented below (as outlined in Option 5.2 and Option 5.3).
Given the relevance of the Review to patients, pharmacies, wholesalers, government and others, the
approach adopted in this report seeks to analyse the effects that the current pharmacy remuneration
and regulation, and the potential options for reform, have on the welfare of the nation as a whole. To
that extent, this report presents the analysis from different perspectives and care should be taken to
interpret it accordingly. The different perspectives may present results that appear contradictory or
repetitive in some cases. However, this report highlights the relevant matters from the different
perspectives and does not seek to form opinions or recommendations. The welfare of the nation as a
whole can be assessed using the following perspectives:
distributional equity – the extent to which current arrangements, and any proposed changes to
those arrangements, achieve the government’s objective of ensuring that:
Australians have equitable access to affordable medicines, regardless of their location and
wealth; and
pharmacies receive equitable remuneration to compensate them for the efficient costs of
supplying medicines on behalf of the government;
economic efficiency – the extent to which current arrangements and any proposed changes to
those arrangements encourage the:
efficient use of medicines, as well as other goods and services (“consumption efficiency”); and
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efficient supply of medicines, as well as other related goods and services (“production
efficiency”);
fiscal sustainability – the extent to which the current remuneration arrangements and any
proposed changes to those arrangements are sustainable in the medium to longer term.
Data limitations and their implications
It is important to have detailed, up to date, information on the efficient marginal costs that pharmacies
would incur in the provision of medicines on behalf of the government. This enables an assessment of
the effects of the current pharmacy remuneration and regulation, as well as any of the Panel’s
proposed changes, on distributional equity, economic efficiency, and the financial sustainability of
those arrangements.
Given the absence of such information, the analysis in this report has had to rely instead on the
limited information available to the Review on the actual average revenues and costs that different
types of pharmacies derive and incur. That information is outlined in section 1.2, summarised in Table
12 and is set out in greater detail in Appendix 2 of this report.
These data limitations have significant implications for the:
approach adopted in this report to assess the effects of the current arrangements and any
proposed changes to those arrangements on distributional equity, economic efficiency and fiscal
sustainability. In general, this involves identifying the:
intended effects of the current arrangements, drawing from the National Medicines Policy;
actual effects of those arrangements, which involves assessing both the intended and
unintended effects of the current arrangements; and
effects that any proposed changes to the current arrangements may have on the extent to
which the arrangements achieve their intended objectives;
interpretation of the results of the analysis set out in this report. It means that the results of the
analysis in this report should be interpreted with caution, particularly the financial reports
developed for each type of pharmacy and their estimated effective rates of assistance in section
2.2.
Throughout this report, where pharmacy or wholesaler remuneration is referred to in relation to PBS
data, it is referring to the estimated remuneration and not necessarily the actual remuneration entities
receive. This is due to the fact that trading terms, discounts and rebates etc. between manufacturers,
wholesalers and pharmacies are not known.
Distributional equity
Equity of access of Australians to affordable medicines
As discussed in section 2.1, consistent with the National Medicines Policy, a key objective of the
current pharmacy remuneration and regulation is to increase the welfare of the nation as a whole by
improving the equity of access of Australians to affordable medicines, regardless of their location and
wealth.
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In order to assist the Review to determine how the current pharmacy remuneration and regulation
have affected “physical” access to medicines, a Geospatial Information System (GIS) model was
developed that provides information on the:
number, location and PBS revenue received by each of pharmacy; and
number, socio-economic status and location of the surrounding population of Australians that
each of these pharmacies serve.
Like previous studies, the results of the analysis suggest that:
the largest number of pharmacies are located in those areas of Australia where the highest
number of people live (e.g. see Figure 1 for an indication of the distribution of pharmacies across
Australia); and
the residents of Australia’s major cities do not have to travel very far to visit their nearest
pharmacy, including the residents of those regions with the highest socio-economic disadvantage
(e.g. see Figure 2 for an indication of the distribution of pharmacies in Sydney as well as
Appendix 1 which sets out similar figures for other capital cities).
Unlike previous studies, however, the results of the analysis also suggest that:
the further Australians live outside major cities, the further they have to travel to visit their nearest
pharmacy. This includes the residents of those regional areas with the highest levels of socio-
economic disadvantage (e.g. see Figure 3, Figure 4 and Figure 5); and
residents of very remote areas of Australia have to travel the furthest to visit their nearest
pharmacy, including the residents of those regional areas with the highest levels of socio-
economic disadvantage (e.g. see Figure 4).
In addition to analysing the physical access that Australians have to the medicines they need, the
affordability of those medicines have also been examined. This affordability is influenced by a range
of factors, some of which are outside the scope of the Review, such as the patient co-payments set
by the Pharmaceutical Benefits Scheme (PBS), and some of which are within the scope of the Review
(e.g. the ability of pharmacies to discount the co-payment by up to $1 for over co-payment scripts and
to charge different prices for under co-payment scripts). The results of the analysis indicate that:
the PBS has the effect of providing higher levels of assistance to those patients who require
greater quantities of higher priced medicines (e.g. as indicated in Table 2, the nominal rate of
assistance that is provided to patients increases with the cost of the medicine prescribed).
Specifically, the required co-payments ($38.80 for general patients and $6.30 for concessional
patients):
do not provide a subsidy to patients whose scripts are under their relevant co-payment.
Although this may be considered to be inequitable, this is an inevitable consequence of the
government’s decision to limit the fiscal costs of the PBS;
provide a subsidy to those patients whose scripts are over the relevant co-payment. These
patients are provided with a level of assistance that increases as the cost of the script
increases. This has the intended effect of providing higher levels of assistance to those
patients who require greater quantities of medicines, and/or higher priced medicines, to meet
their particular health needs. However, it may provide patients with higher levels of assistance
when they use higher cost medicines that might not be more effective, or only marginally
more effective, than other lower cost medicines. There are a number of strategies to help to
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reduce or remove this effect, including the requirement that PBS medicines have to go
through thorough independent clinical and cost effectiveness assessments prior to listing1.
the ability of pharmacists to charge patients prices that differ from the dispensed price for under
co-payment medicines and apply the $1 discount to over co-payment scripts has the intended
effect of improving the affordability of medicines to some patients. However:
as a result of differences in the levels of competition between pharmacies across Australia,
the ability of pharmacies to charge different prices for medicines does not appear to have
resulted in lower medicine prices for all Australians. Rather, it appears to have resulted in
lower prices of medicines for some patients, but higher prices of medicines for other patients.
For example, Table 7 suggests that these price variations provide general under co-payment
patients that purchase their medicines from PhARIA 1 pharmacies with a 9% rate of
assistance, whereas those who purchase their medicines from PhARIA 3 to PhARIA 6
pharmacies actually have to pay progressively more for their medicines (they receive
progressively more negative nominal rates of assistance as a result of those price variations);
“micro” pharmacies with an annual turnover of less than $2m appear to charge their patients
more as a result of their ability to vary the prices they charge for medicines. Table 9 suggests
that price variations result in patients who purchase their medicines from micro PhARIA 1
pharmacies paying 6% more for their medicines. This negative rate of assistance becomes
even more negative as the micro pharmacies become more remote. Those patients who
purchase their medicines from micro PhARIA 6 pharmacies appear to have paid 32% more
for their medicines;
medium sized PhARIA 1 pharmacies appear to provide the highest assistance to their
patients as a result of the ability of pharmacies to vary their prices (pharmacies with an annual
turnover of $10m to less than $20m);
PhARIA 1 pharmacies appear to apply the $1 discount to the highest proportion of scripts and
the major beneficiaries of those discounts are concessional non-safety net patients. As
pharmacies become more remote, however, the proportion of scripts they discount appears to
decrease significantly (e.g. see Figure 8);
the combined effect of these price differences and the $1 discount appear to provide the
highest levels of assistance to “general under co-payment” patients and “concessional”
patients ($97.8m to “general under co-payment” patients and $49.9m to “concessional”
patients, as indicated in Table 10);
the pharmacy location rules appear to have the intended effect of spreading pharmacies across
those areas where most of Australia’s population lives. However, in so doing, they may also have
the unintended effect of potentially restricting the density of pharmacies in those areas where
there is a much greater density of population during the day, for example, areas where
Australians work, visit health centres, shop and use public transport. As indicated in Figure 6, only
54 per cent of all scripts are purchased from pharmacies located in the same postcode as where
the patient resides, whereas 45 per cent of all scripts are purchased from pharmacies in another
postcode. A more detailed breakdown of where different types of patients purchase their
medicines is provided in Table 1;
many Australians currently have the ability to purchase their medicines online which has the
potential, in theory, to increase their equity of access to affordable medicines, particularly those
1 The Pharmaceutical Benefits Scheme, http://www.pbs.gov.au/info/about-the-pbs, accessed 9 May 2017
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Equity of pharmacy remuneration arrangements
As discussed in section 2.2, current pharmacy remuneration and regulation are also intended to
ensure that pharmacies receive sufficient remuneration to enable them to cover the efficient costs of
supplying medicines on behalf of the government.
However, the current pharmacy remuneration is not the result of the same rigorous process that is
used to estimate the fees paid by the government to suppliers of other essential services (they are not
the result of “building block” models that are used to estimate the efficient costs of supplying other
essential government services, such as electricity, gas, water, telecommunications and some
transport services). Rather, those current fees are more a reflection of historical precedent, as
modified by successive rounds of negotiation between the Pharmacy Guild and the government.
As a result, there is very little information available at the moment on the efficient marginal costs of
supplying medicines. Rather, most of the information that has been provided to the Review relates to
the average revenue and costs that pharmacies actually derive and incur from supplying all of the
goods and services they sell, as opposed to the efficient marginal costs of supplying medicines on
behalf of the government. Table 12 suggests the extent to which the various sources of data currently
available on pharmacy revenues and costs differ across different types of pharmacies. In particular, it
suggests that the average cost per script varies from $6.66 to $12.33. A more detailed outline and
comparison of these various sources of financial data is provided in Appendix 2.
The analysis of the limited pharmacy financial data available suggests that:
there is little evidence from the data that pharmacies are earning economic rents, as
indicated in Table 13. Rather, it appears that there is enough competition between pharmacists
looking to purchase an existing pharmacy or establish a new pharmacy under the location rules,
to capitalise the value of any short term economic rents into asset values in the longer term (e.g.
into the higher prices that pharmacists must pay for the rental of their premises and the goodwill
of the businesses they purchase). This creates long term inefficiencies in the use of the nation’s
scarce resources; and
the current pharmacy remuneration and regulation may also have the unintended effect of
providing those pharmacies that add the least economic value to their inputs or make the most
inefficient use of their resources, with the highest effective rates of assistance (as illustrated in the
hypothetical example provided in Table 15).
In addition, the results of the analysis of the effects of potential reforms to the current pharmacy
remuneration and regulation identified in the Review’s Interim Report suggest that:
paying pharmacies a flat dispensing fee in the range from $9.00 to $11.50 per script (Option 4.3)
would potentially improve the equity of current pharmacy remuneration arrangements by reducing
unintended differences in the effective rates of assistance afforded different types of pharmacies
(as indicated in Table 18 and Table 19, which consider the effects of implementing an illustrative
flat fee of $10 per script). Any reference in this report to a $10 flat fee represents a hypothetical
fee for dispense that was selected from within the range proposed by the panel in option 4.3 and
is merely illustrative.
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the removal of current location rules (Option 5.1) has the potential to improve the equity of current
pharmacy remuneration arrangements by reducing the extent to which those rules:
prevent pharmacies from locating in those areas where there is the highest demand for the
particular types of medicines and services they supply; and
provide less efficient pharmacies with higher levels of assistance than more efficient
pharmacies. For example, by potentially preventing new, more efficient, pharmacies from
locating nearby existing pharmacies supplying similar medicines).
Economic efficiency
Consumption efficiency
As discussed in section 3.1, although the National Medicines Policy notes that cost should not
constitute a substantial barrier to people’s access to the medicines they need, it also notes the
importance of ensuring that the arrangements used to promote that improved access are consistent
with the “rational” use of those medicines.
In seeking to improve the equity of access to affordable medicines across patients with different
health needs and incomes, however, the PBS in conjunction with the current pharmacy remuneration
and regulation also have the potential to unintentionally alter the decisions that individual patients and
particularly their medical practitioners make regarding the types and quantities of medicines that they
should use in order to meet their specific health needs.
In particular:
Table 2 illustrates how by setting the co-payment for general patients at $38.80 per script, the
PBS reduces the relative prices of higher cost medicines to general patients in relation to lower
cost medicines by providing the patient with a higher “nominal rate of assistance” when they use a
higher cost medicine. This has the potential to result in the use of less cost effective medicines.
However, there are stringent measures in place to reduce or eliminate this effect such as the
requirement for medicines to be subjected to stringent cost effectiveness assessments before
being listed on the PBS.
Table 5 in section 2.1.2 suggests that the ability of pharmacies to vary the prices they charge for
general under co-payment scripts alters the relative prices that general patients paid for the top
10 medicines.
The results of the analysis of the effects of implementing a uniform price across all patients for each
type of medicine (Option 2.1 and Option 2.2) suggest that such a reform has the potential to improve
consumption efficiency to the extent that it succeeds in reducing differences in the relative prices that
patients are charged for each particular type of medicine they use.
Production efficiency
The current pharmacy remuneration and regulation are also intended to improve the efficiency with
which those medicines are supplied (“production efficiency”) and deliver “value for money”, which is
an important objective identified by the National Medicines Policy.
However, in the course of increasing the quantities and types of medicines available to Australians
and the ease of access that Australians have to community pharmacies, the current pharmacy
remuneration and regulation also have the potential to impose a net economic cost on the nation as a
whole by unintentionally encouraging less efficient levels and patterns of production, investment, and
resource use (“production inefficiencies”).
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In particular, the current ownership and location rules may also have adverse effects on production
efficiency by reducing the level of competition and altering the nature of competition between
pharmacies and other businesses. Specifically, the:
pharmacy location rules may have encouraged the emergence of large numbers of very small
pharmacies and provided a competitive advantage to existing pharmacies in the markets for their
outputs, inputs and factors of production (land, labour and capital); and
pharmacy ownership rules may have the effect of reducing the competition that pharmacies face
in the markets for their outputs, inputs and factors of production from much larger retailers.
In addition, the current remuneration arrangements do not pay pharmacies different fees for all of the
different value adding activities they perform. Rather, they often pay pharmacies the same fee for
performing a range of different value adding activities. Dispensing, for example, which can involve
activities that add little economic value, such as labelling pre-packaged medicines, through to higher
economic value adding activities that involve much more complex activities by the pharmacist,
including consulting prescribers for particular scripts).
This has the unintended effect of providing the highest effective rates of assistance to those activities
that add the least economic value to the inputs used by those activities. As outlined in Table 15, low
economic value adding activities are provided with higher effective rates of assistance than higher
economic value adding activities.
The analysis of the effects of alternative options for reforming the current pharmacy remuneration and
regulation identified in the Review’s Interim Report suggests that:
paying pharmacies a flat dispensing fee in the range from $9.00 to $11.50 per script (Option 4.3)
has the potential to improve production efficiency by:
reducing the effective rates of assistance currently provided to each type of pharmacy. The
implementation of an illustrative flat fee of $10 per script would reduce the effective rate of
assistance provided to micro, profitable, pharmacies from 32% to 17%, a 46% reduction;
reducing the differences in the effective rates of assistance afforded the different types of
pharmacies. Prior to the introduction of the illustrative $10 flat fee for dispensing, the effective
rates of assistance afforded profitable, taxable, pharmacies range from 32% to 108% for
profitable, taxable pharmacies. By contrast, after the introduction of the $10 flat dispensing
fee, the effective rates of assistance would range from 7% to 53% for profitable and taxable
pharmacies; and
removing the current location rules (Option 5.1) has the potential to improve production efficiency
by:
enabling pharmacies to locate in those areas where there is the highest demand for the
particular types of medicines and services they supply;
reducing the extent to which the current location rules shield pharmacies from increased
competition from other pharmacies. Although the current location rules might have improved
economic efficiency to some extent by reducing rent seeking activity, those rules appear to
have done little to constrain the emergence of a large number of very small pharmacies that
are clustered around major population centres;
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facilitating the increased use of electronic prescriptions (Option 2.7) has the potential to improve
not only the equity of access of Australians in the more remote regions of Australia to affordable
medicines, but may also improve the efficiency with which medicines are produced by pharmacies
by:
reducing the administrative costs that pharmacies currently incur in order to process paper
scripts;
reducing the extent to which the current ownership and location rules reduce the competition
faced by less efficient pharmacies, since it is likely that all pharmacies would face increased
competition from online pharmacies, thereby increasing the incentive to improve their
efficiency; and
enabling pharmacies to utilise any spare capacity they might have to supply additional
medicines online.
Fiscal sustainability
In addition to improving the equity of access to affordable medicines and reducing any perverse
effects that pharmacy remuneration and regulation arrangements might have on economic efficiency,
the National Medicines Policy also stresses the need for those arrangements to be financially
sustainable:
However, in the course of seeking to raise a sufficient and sustainable source of revenue to fund the
provision of subsidised medicines, the current pharmacy remuneration and regulation, in conjunction
with the tax system, also have a range of potentially adverse effects on economic efficiency.
In particular, as illustrated in Table 24, each dollar that is raised by the government through the tax
system to fund the current pharmacy remuneration and regulation comes at a real economic cost to
the community equal to the sum of the:
opportunity cost of each dollar invested in remunerating pharmacies and administering pharmacy
regulations ($1 plus an assumed 7% real rate of return that could be earned on that dollar if it was
invested in the next best investment); and
additional “deadweight cost” of raising that dollar through the tax system (which is assumed to be
20% of that investment).
Accordingly, the economic cost of each dollar spent by the government on pharmacy remuneration
and regulations is around $1.27. This means that significant benefits can be generated for the nation
as a whole by reducing any inefficient expenditure on pharmacy remuneration and regulation that is
not generating a social rate of return of at least 27 per cent.
In particular, as set out in Table 25, it is estimated that the introduction of a flat fee for dispensing
(Option 4.3) would potentially save $1.5b of fiscal costs over the period 2015-16 to 2019-20 if the flat
dispensing fee was set at $10 per script.
These fiscal cost savings, however, underestimate the potential savings in economic costs that would
arise from the implementation of such a measure, which are estimated to be $1.9b of economic costs
over the period 2015-16 to 2019-20 if the flat dispensing fee was set at $10 per script.
14
INTRODUCTION
1.1 Purpose and structure of this report
In effect, the Terms of Reference for the Review raise two key questions:
To what extent are the current pharmacy remuneration and regulation achieving their intended
objectives?; and
To what extent would the welfare of Australians be improved by any proposed changes to those
current arrangements?
This report summarises the results of the financial analysis that has been conducted in order to help
the Review answer these two key questions. Specifically, this report presents the key results of the
analysis of the effects that both the current arrangements, and potential changes to those
arrangements identified in the Review’s Interim Report, have on the key factors that influence the
welfare of Australians, namely:
distributional equity (section 2) – that is, the extent to which current arrangements, and any
proposed changes to those arrangements, achieve the government’s objective of ensuring that:
Australians have equitable access to affordable medicines, regardless of their location and
wealth; and
pharmacies receive equitable remuneration to compensate them for the efficient costs of
supplying medicines they supply on behalf of the government;
economic efficiency (section 3) – that is, the extent to which current arrangements and any
proposed changes to those arrangements encourage the:
efficient use of those medicines, as well as other goods and services (consumption
efficiency); and
efficient supply of medicines, as well as other goods and services (production efficiency);
fiscal sustainability (section 4) – that is, the extent to which the current remuneration
arrangements and any proposed changes to those arrangements are sustainable in the medium
to longer term.
The appendices to this report provide:
information on the equity of access that the residents of Australia’s capital cities have to
community pharmacies (Appendix 1);
summary of the various sources of pharmacy financial data provided to the Review, which are
outlined further in section 1.2 below (Appendix 2);
detailed profit and loss statements for each of the key types of pharmacies that have been
identified for the purposes of this report, which have been developed from the key sources of
financial data outlined in section 1.2 below (Appendix 3);
a comparison of the financials for micro pharmacies against comparable businesses (Appendix
4);
details regarding a range of selected methodologies that have been used for the purposes of the
analysis in this report (Appendix 5);
15
case studies on Rural Pharmacy Maintenance Allowance payable to pharmacies (Appendix 6);
additional detailed information regarding a range of issues of interest to the Review, including
average revenue per script, high cost medicines, electronic prescriptions and dangerous drugs,
trends in dispensing by hospital pharmacies, and Additional fees paid to TGA licensed
chemotherapy compounding facilities (Appendix 7); and
commercial in confidence information presented to the Review (Appendix 8 and Appendix 9).
1.2 Key sources of financial data
In order to conduct a rigorous analysis of the effects that the current pharmacy remuneration
arrangements have on distributional equity, economic efficiency, and the fiscal sustainability, it is
essential to have detailed information on the efficient marginal costs that pharmacies would have to
incur to supply medicines on behalf of the government.
In view of the lack of such information, the analysis conducted in this report has had to rely instead on
the limited information that was available to the Review on the average revenues and costs incurred
by different types of pharmacies, which includes the:
data provided by . This provides the most comprehensive, consistently derived and
independent data on total revenues and expenses derived and incurred by pharmacies for
2013/14;
PBS data on the amount of remuneration that each pharmacy received from the government and
patients, as well as the cost of the pharmaceuticals they purchase (valued using ex-
manufacturer’s prices, rather than actual prices paid);
data, which provides information on the value of capital that pharmacies of
different sizes typically invest in their businesses;
Pharmacy Guild Digest survey data on independent pharmacy operations in Australia for the
2014-15 financial year, which presents financial data obtained from a sample of 313 pharmacies
weighted according to their prescription volumes;
data, provides financial information for a sample of 205 pharmacies
across Australia in the 2016 financial year and 371 pharmacies in the 2015 financial year;
data sourced from Benchmarking.com.au, which provides financial benchmarking data for the
2016 financial year on:
pharmacies, obtained from a sample of 132 pharmacies;
a range of other similar retail businesses (e.g. corner stores, health food retailers, medical
practices and supermarkets);
data sourced from the financial survey conducted by the Review, that provides financial data for
the pharmacies that responded to that survey.
16
Rather than rely on just one of these sources of data, a financial model has been constructed that
makes the best possible use of all of these existing sources of financial information. For example:
data has been used as a primary source of information on the total revenue incurred by
different types of pharmacies;
PBS data has been used as the primary source of information on the revenue that pharmacies
derive from the supply of PBS medicines;
data has been used to estimate the cost of capital that is incurred by pharmacies
of different sizes;
Pharmacy Guild survey data, data and financial performance
benchmarking data for pharmacies have been used as the primary sources of information on the
composition of the total financial costs incurred by pharmacies and the manner in which those
costs vary depending on the ratio of revenue that pharmacies derive from PBS and non PBS
sources;
financial benchmarking data for comparable businesses has been used to benchmark pharmacy
data; and
responses received to the financial survey conducted by the Review have been used to “reality
check” the results of the financial analysis.
It is essential to note that this approach has important implications for the interpretation of the results
of the analysis using that data.
In particular, it means that considerable caution needs to be exercised when interpreting the results of
the analysis, particularly the:
financial statements that have been developed for each type of pharmacy; and
estimates of the effective rates of assistance that the current pharmacy remuneration and
regulation provide to these different types of pharmacies.
At best, the results are indicative and highlight the need for more rigorous analysis using accurate
estimates of the efficient costs of pharmacies supplying medicines on behalf of the government.
17
DISTRIBUTIONAL EQUITY
A key objective of the current pharmacy remuneration and regulation, which is reflected in the
National Medicines Policy, is to increase the welfare of the nation as a whole by improving
“distributional equity”, namely the:
equity of access of Australians to affordable medicines; and
equity of access of pharmacies and wholesalers to sufficient revenue to compensate them for the
efficient costs of supplying those medicines on behalf of the government.
However, as discussed further below, in the course of seeking to achieve these intended equity
objectives, the PBS in conjunction with the current pharmacy remuneration and regulation also
potentially impose real economic costs on the nation as a whole by introducing:
additional inequities in the equity of access of Australians to affordable medicines; and
additional inequities in the remuneration that pharmacies and wholesalers receive for the
medicines they supply on behalf of the government.
This section:
identifies the intended effects of the current PBS and pharmacy remuneration and regulation on
distributional equity;
outlines available information on the actual effects of these current regulatory and remuneration
arrangements, which include both their intended and unintended effects on distributional equity;
and
discusses the extent to which proposed changes to those current arrangements are expected to
improve their intended equity objectives.
2.1 Equity of access of Australians to affordable medicines
2.1.1 Intended effects on the equity of access of Australians to affordable medicines
The fundamental objective of the current pharmacy remuneration and regulation is to improve the
equity of access that Australians have to the types and quantities of affordable medicines that they
need to meet their health needs, regardless of where they live in Australia and their wealth. This
equity of access objective is central to the objectives of the National Medicines Policy, which are:
timely access to the medicines that Australians need, at a cost individuals and the community can
afford;
medicines meeting appropriate standards of quality, safety and efficacy;
quality use of medicines; and
maintaining a responsible and viable medicines industry.2
2 Department of Health and Ageing (2000). National Medicines Policy, p1.http://www.health.gov.au/internet/main/publishing.nsf/Content/B2FFBF72029EEAC8CA257BF0001BAF3F/$File/NMP2000.pdf
18
In particular, the current pharmacy remuneration and regulation arrangements are intended to
address the concern that, in the absence of such government interventions, the operation of the
market will fail to supply Australians with:
sufficient information on the various types of medicines that are available to meet the specific
health needs of the individual and the relative efficacy of each of those alternatives (e.g. due to
“information asymmetries” between pharmacists and patients of medicines, as well as the “public
good” nature of information on medicines, which are discussed further in section 3);
sufficient quantities of the various types of medicines that they need to meet their health needs
due to the:
high prices of many medicines. In view of the high fixed costs involved in the production of
pharmaceuticals, manufacturers often need to charge prices that significantly exceed the
economically efficient marginal costs of supplying those pharmaceuticals; and
limited incomes that many Australians have to purchase the medicines they need.
The current pharmacy remuneration and regulation are intended to improve the equity of access to
affordable medicines by addressing these sources of “market failure”. Specifically, the current:
pharmacy ownership regulations, which are imposed by each State and Territory government and
are outside the Terms of Reference of the Review, are intended to ensure that Australians receive
high quality advice on the types and quantities of medicines they need to meet their specific
health needs. The concern is that, in the absence of such rules, the advice provided by
pharmacies would be driven more by commercial considerations rather than by the health needs
of their customers;
pharmacy location rules are intended to improve the physical access that Australians have to the
medicines they need. Since the government has restricted the supply of certain medicines to
pharmacies for public safety reasons (“prescription” and “pharmacy only” medicines), there is a
concern that in the absence of such pharmacy location rules, pharmacies would cluster around
the most profitable locations, rather than incur the additional costs required to provide services to
meet the health needs of those Australians who live in more remote locations; and
pharmacy and wholesaler remuneration arrangements, in conjunction with the Pharmaceutical
Benefits Scheme (PBS), are intended to reduce the prices that Australians would otherwise have
to pay for the medicines they need to meet their health needs by equitably compensating
pharmacies and wholesalers for the efficient costs of supplying medicines on behalf of the
government.
2.1.2 Actual effects on the equity of access of Australians to affordable medicines
In order to assist the Review to determine how the current pharmacy remuneration and regulation
have affected the equity of access of Australians to the medicines they need (their “physical” access
to those medicines), a Geospatial Information System (GIS) model has been developed that provides
information on the:
number, location and PBS revenue received by each of pharmacy; and
number, socio-economic status and location of the surrounding population of Australians that
each of these pharmacies serve.
This model provides the user with the ability to assess the:
19
actual effects of the current pharmacy remuneration and regulation on the equity of access of
Australians who are resident in different regional areas to the medicines they need; and
extent to which proposed changes to the current pharmacy remuneration and regulation are likely
to:
improve the equity of access of Australians to the medicines they need; and
alter the profitability of pharmacies. As discussed further in section 3, the geospatial analysis
of the location of pharmacies has been linked the financial analysis of the profitability of
pharmacies in order to help identify how any proposed changes to current pharmacy
remuneration arrangements are likely to alter the profitability of pharmacies across Australia
(e.g. by identifying the locations of those pharmacies that are most likely to be adversely
affected by any reduction in current remuneration arrangements).
How equitable is the access of Australians to medicines?
Some indication of the existing equity of access of Australians to medicines provided by pharmacies
is provided by:
Figure 1 which indicates the number of pharmacies in each regional area of Australia as well as
the relative index of socio-economic disadvantage (SEIFA index – the darker red indicates areas
of greater socio-economic disadvantage). This suggests that:
since most pharmacies in Australia are located in the major capital city and regional
population centres, the residents of those cities have the best access to the medicines
provided by pharmacies; and
by contrast, those Australians that live in the more remote regions of Australia have less
equitable access to the medicines provided by pharmacies;
Figure 2, which indicates the number and location of pharmacies in the Sydney regional area,
which includes the CBD and surrounding regions. Similar figures are provided for all other capital
cities in Appendix 1 of this report. In addition, Appendix 8 also provides confidential data on the
amount of total PBS remuneration received by each pharmacy in Sydney and Melbourne. This
suggests that:
once again, most pharmacies in Sydney and its surrounding regions are located in where
most of the population lives; and
there is also a good coverage of pharmacies across the most socially disadvantaged areas of
Sydney (as indicated by the dark red regions);
Figure 3 which indicates the distance to the closest pharmacy against the SEIFA index for that
region. Separate graphs for each of these regional areas are provided in Figure 4. Figure 3 and
Figure 4 suggests that:
the residents of the wealthiest areas of Australia (those with the highest SEIFA indexes) have
the best access to community pharmacies (they have a community pharmacy located
nearby);
although the residents of those regional areas of Australia with average indexes of socio-
economic disadvantage (a SEIFA index of around 1) also have good access to community
pharmacies, there are still some of these regional areas where residents have to travel
significant differences to visit their closest pharmacy; and
20
the residents of those regional areas of Australia with the greatest socio-economic
disadvantage (with the lowest SEIFA indexes) also have to travel significant distances to visit
their nearest pharmacy;
Figure 5, which is the same as Figure 4, except the vertical distance to the nearest pharmacy
scale has been magnified so that it only goes up to 25km. This indicates the existence of a similar
trend across all regional areas of Australia, namely the need for the residents of many regions
with SEIFA indexes ranging from around 750 to 1100 to travel up to 25km to visit their nearest
pharmacy.
Figure 1: Distribution of pharmacies across Australia
Source: PBS data
Notes: The yellow circles represent the number and geographical distribution of pharmacies. The numbers inside
the circles show the number of pharmacies.
21
Figure 2: Distribution of pharmacies across regional areas of Sydney
Source: PBS data
Notes: The yellow circles represent the number and geographical distribution of pharmacies. The numbers inside
the circles show the number of pharmacies.
22
Figure 3: Distances that different socio-economic groups have to travel to visit the nearest pharmacy
Source: PBS data
Figure 4: Distances that different socio-economic groups have to travel to visit the nearest pharmacy (broken down by regional areas)
Source: PBS data
23
Figure 5: Distances that different socio-economic groups have to travel to visit the nearest pharmacy (broken down by regional areas) – magnified distance scale
Source: PBS data
When assessing the equity of access that Australians have to affordable medicines, however, it is
important to note that a significant proportion of Australians are not located at their principal places of
residence for the entire day (e.g. people of working age). Rather, each day, they typically visit a wide
range of other locations to work, shop and visit their health professionals to purchase the goods
services they need. This means that the normal place of residence of an individual does not
necessarily provide an accurate indication of the locations where people will seek to purchase their
medicines.
Some plausible explanations include:
older, non-working age people who are less mobile are more likely to be seeking to purchase their
medicines from medical practitioners and pharmacies that are located near the location in which
they reside (e.g. their local shopping centres);.
working age people who are not able to attend work may seek to purchase their medicines from
pharmacies located near to their medical practitioners who prescribe their medicines, local
shopping centres or their principal place of residence; and
working age people whose medical needs are such that they can continue working, or people who
are purchasing medicines on behalf of their partners or dependents, may seek to visit doctors and
purchase their medicines from pharmacies located in the other locations where they work, shop or
travel;
24
As illustrated in Figure 6, an analysis of PBS data on the place of residence of the patient, the location
of the medical practitioner who prescribes those medicines, and the location of that pharmacy that
supplies those medicines confirm these trends to some extent:
54 per cent of all scripts are purchased from pharmacies located in the same postcode as the
patient resides:
34 per cent of all scripts are prescribed by medical practitioners, and filled by pharmacies, in
the same postcode as the patient resides (e.g. as would be the case if the patient visits a
doctor in their local shopping centre and then gets their script filled by a pharmacy located in
the same shopping centre);
20 per cent of all scripts are filled by pharmacies in the same postcode as the patient is
located, but are prescribed by medical practitioners in another postcode (e.g. as would be the
case if the patient has to travel to another postcode to visit their medical practitioner, but has
their prescription filled by a pharmacy located their local shopping centre that is located in the
same postcode where they reside);
45 per cent of all scripts are purchased from pharmacies in another postcode:
29 per cent of all scripts are filled by pharmacies located in a postcode that differs from the
postcode where the patient resides and the postcode where the medical practitioner that
prescribes the medicine is located (e.g. as would be the case if the patient has to leave their
postcode to visit their medical practitioner and then travel to another different postcode to visit
their pharmacy). Only 10 per cent of the people who have to travel to another postcode to
have their script filled come from a postcode in which there is no pharmacy. In order to have
these scripts filled:
− 25 per cent of these scripts filled require the patient to travel up to 4.7km to visit the
pharmacy;
− 50 per cent of these scripts require the patient to travel up to 9.8km to visit the
pharmacy;
− 75 per cent of these scripts require the patient to travel up to 26.5km to visit the
pharmacy; and
17 per cent of all scripts are prescribed by medical practitioners who are located in the same
postcode as the location as the pharmacy that fills that script, but in a different postcode than
where the patient resides (e.g. as would be the case if the patient travelled to another location
to visit their medical practitioner and then get their script filled by a pharmacy located near
that medical practitioner, as would be the case if they visited a health clinic, or a doctor in a
shopping centre that also has a pharmacy).
25
Figure 6: Location of the patient, prescriber and pharmacy
Source: PBS data
Notes: See Appendix 5 for outline of methodology used
A more detailed breakdown of the respective locations of the patient, prescriber and pharmacy for
different types of patients (e.g. general and concessional patients) is provided in Table 1 below. The
results of this analysis by type of patient are broadly consistent with those outlined above. That is:
concessional patients tend to have their scripts prescribed by medical practitioners, and filled by
pharmacies, that are located in the same postcode in which they reside, which may be a reflection
of their lower regional mobility. For example:
“concessional safety net patients” tend to have the highest proportion (40%) of their
prescriptions prescribed and filled by medical practitioners and pharmacies that are located in
the same postcode in which they reside;
“concessional non-safety net patients” have a slightly lower proportion of their scripts (37%)
prescribed and filled by medical practitioners and pharmacies located in the same postcode
as they reside;
general patients tend to have lower proportions of their scripts prescribed and dispensed by
medical practitioners and pharmacies that are located in the same postcode as they reside, which
may reflect their greater regional mobility and hence lower generalised costs of visiting those
more remote pharmacies. For example:
“general safety net patients” have a slightly lower proportion of their scripts (32%) prescribed
and filled by medical practitioners and pharmacies located in the same postcode as they
reside; and
“general patients” have the lowest proportion of their scripts (23% for over co-payment scripts
and 28% for under co-payment scripts) prescribed and filled by medical practitioners and
pharmacies located in the same postcode as they reside.
26
Table 1: Location of patient, prescriber and pharmacy, by type of patient
Source: PBS data
Notes:
1. Includes community pharmacy and hospital pharmacy data for 2015-16
This means that the current pharmacy regulations, which tend to focus on where patients reside, may have the unintended effect of creating an:
undersupply of pharmacies in those areas where there is high population density during the day
(e.g. those locations where there are high levels of foot traffic, such as the retail and transport
hubs of central business districts where relatively few people live, but large numbers of people
come to work each day and are looking for a convenient place to purchase their medicines); and
oversupply of pharmacies in those areas where most of the people that reside in that area spend
a significant proportion of their time each week in another regional area (e.g. those regions where
the resident are of working age and travel each day to another region to work).
This also highlights the need to consider the range of medicines supplied by pharmacies, the range
and quantity of stocks of medicines held by the pharmacy, and their hours of operation when
assessing the equity of access to the medicines they need. In particular, the existence of a pharmacy
in the same postcode as a patient is unlikely to improve that patient’s access to the medicines they
need if the pharmacy:
does not supply the medicine needed by that patient;
is capable of providing the medicine supplied by the patient but does not hold sufficient stocks of
that medicine to meet the patient’s needs (granted that under the CSO arrangements the
pharmacy would be able to have the medicine on hand within 24 hours);
is not open when the patient wants to visit that pharmacy (e.g. as would be case if the patient is of
working age and travels to another postcode to work); or
is not known to the patient (e.g. although the extent of this may be limited, patients living in, or
visiting, some of the more remote regions of Australia might not be aware of the locations of the
162 remote area health services around Australia and their ability to obtain medicines from those
services).
Location of consumer, prescriber and pharmacy
Consumer
and
pharmacy in
same
postcode
Prescriber
and
pharmacy in
same
postcode
Consumer,
prescriber
and
pharmacy in
same
postcode
Consumer,
prescriber
and
pharmacy in
different
postcodes
Concessional non-safety net 145,061,002 49% 58% 53% 37% 26%
Conessional safety net 43,712,612 15% 63% 53% 40% 24%
General non-safety net (over co-payment) 14,486,038 5% 45% 41% 23% 37%
General non-safety net (under co-payment) 80,762,096 27% 46% 47% 28% 34%
General safety net 3,192,802 1% 58% 46% 32% 28%
RPBS non-safety net 7,408,118 2% 59% 53% 39% 27%
PRBS safety net 2,936,671 1% 47% 53% 31% 31%
Prescriber Bag 382,285 0% 0% 72% 0% 27%
ALL 297,941,624 100% 55% 51% 34% 29%
Patient typeNumber of
scripts
Percentage
of total
scripts
27
In addition, when assessing the equity of access to medicines, it is also important to note that all
Australians are able to purchase their medicines on-line if they so desire. In theory, this option should
be particularly attractive for those individuals who:
are located in the more remote regions of Australia where the patient would otherwise have to
travel long distances to visit their nearest pharmacy;
have mobility problems (e.g. older age and disabled individuals); and
have a high opportunity cost of time (e.g. high income individuals who lack the time necessary to
visit pharmacies in person to have their scripts filled); and
do not require their medicines urgently, thereby allowing for postage times; and
do not require medicines that have particular freight requirements, such as ‘cold chain’.
have access to internet and are computer literate.
Figure 7: Postage times and shipping charges for medicines purchased from ePharmacy
Source: ePharmacy.com.au
How affordable is the access of Australians to medicines?
In addition to improving the equity of access of Australians to the medicines they need (their
“physical” access), the current pharmacy remuneration and regulation, in conjunction with the
Pharmaceutical Benefits Scheme (PBS), are also intended to improve the affordability of those
medicines (their ability to pay for those medicines).
28
As noted by the National Medicines Policy:
“Cost should not constitute a substantial barrier to people’s access to medicines they need.
Therefore normal market mechanisms may be tempered in access arrangements, to increase the
affordability of important medicines. For example, the Pharmaceutical Benefits Scheme (PBS)
facilitates access to certain prescribed medicines by subsidising costs, and subsidies also occur
when hospitals supply medicines to patients. Such subsidies are not costless, and the community
as a whole must bear them.”3
It is important to note that the affordability of medicines to Australians is influenced by a range of
factors, not all of which are within the scope of the Review which focuses on the current pharmacy
remuneration and regulation.
In particular, the cost of medicines to Australians is influenced by both the:
PBS which sets the :
co-payments;
annual safety nets;
costs that patients have to incur in order to compensate pharmacists for the actual costs they
incur in order to fill each script, which are influenced by the:
actual prices that pharmacists charge patients for each script they supply, which can differ
from the dispensed price as a result of pharmacists:
− applying the $1 discount; and/or
− charging prices that are either below, or above, the dispensed price for under co-
payment medicines; and
quantities of medicines prescribed per script by the medical practitioner, which are influenced
by a range of factors outside the scope of the Review, including the:
− health needs of the patient; and
− limits imposed on the total quantities of medicines that can be prescribed by medical
practitioners per script, which are set by the PBS, as well as medical practitioner
prescribing standards.
What effect does the PBS have on the affordability of access to medicines?
As noted above, the PBS is the key instrument that the government has to improve the affordability of
medicines, by:
setting co-payments for different patient categories; and
applying annual safety nets for different patient categories.
As illustrated in Table 2, setting co-payments (e.g. general co-payment of $38.80 on the contributions
required by general patients), tend to provide a higher “nominal rate of assistance” to those patients
that use higher cost medicines. These nominal rates of assistance reflect the extent to which subsidy
3 Department of Health and Ageing (2000). National Medicines Policy, p2.
29
provided by the government proportionally reduces the cost of that medicine to the patient. That is,
the nominal rate of assistance provided to the patients of each medicine is equal to the:
subsidy provided to patients of that medicine, which is equal to the:
cost of the medicine to patients in the absence of a subsidy from the government;
less the relevant co-payment paid by the patient;
divided by the cost of the medicine to patients in the absence of a subsidy from the government.
Table 2: Illustration of how general patient co-payments for different types of medicines provide the highest nominal rates of assistance to patients of the most expensive medicines
This provision of a nominal rate of assistance to patients that increases with the cost of the medicine
prescribed has the intended effect of providing higher levels of assistance to those Australians who:
hold an Australian government concession card, which includes those on lower incomes (the
amount of subsidy provided to those individuals is greater as a result of the lower concessional
co-payment that applies); and
have a greater need for medicines to meet their health needs. In particular, a higher level of
assistance is provided to those patients who have to use:
greater quantities of medicines to meet their health needs (the amount of subsidy increases
as the quantity of medicines they need increases); and
higher priced medicines to meet their health needs (the amount of subsidy increases as the
price of those medicines increases).
Specifically, the PBS does not provide any assistance to those patients who purchase under co-payment scripts (e.g. medicines 1 and 2). Although the patients whose use of medicines consists
predominantly of such medicines might consider this to be inequitable, it is important to note that:
those inequities are the inevitable consequence of the complex trade-offs that need to made in
the course of designing the PBS. These include the trade-offs between the conflicting objectives
of:
equity of access to affordable medicines and fiscal sustainability. Once the government has
decided that it would not be fiscally sustainable to provide all medicines to all Australians free
of charge, it is necessary to reduce the fiscal cost of the PBS by limiting its application to a
Medicine
prescribed on
the script
Cost to
general
consumer
before
government
subsidy
Cost to
general
consumer
after
government
subsidy
Nominal rate
of assistance
to general
consumers
Medicine 1 $20.00 $20.00 0.0%
Medicine 2 $30.00 $30.00 0.0%
Medicine 3 $40.00 $38.80 3.0%
Medicine 4 $50.00 $38.80 22.0%
Medicine 5 $60.00 $38.80 35.0%
Medicine 6 $70.00 $38.80 45.0%
Medicine 7 $80.00 $38.80 52.0%
Medicine 8 $90.00 $38.80 57.0%
Medicine 9 $100.00 $38.80 61.0%
30
specified range of medicines (those listed on the PBS) that have prices in excess of a
particular patient co-payment. Inevitably, this means that although this approach reduces the
fiscal cost of the PBS, that reduction in fiscal cost comes at the expense of introducing
differences into the levels of assistance provided to patients (it means that some Australians
who consume medicines that are either not listed on the PBS, or are under co-payment
medicines, will not receive any government assistance);
equity of access to affordable medicines and economic efficiency. Even if the government
could afford to fully subsidise the cost of all medicines to all Australians, it still might be
desirable to require patients to pay for at least some of the costs of the medicines they use in
order to improve the economic efficiency with which those medicines are used. It is noted that
the prescriber plays an integral part in reducing such inefficient use of prescription PBS
medicines (e.g. to reduce the excessive use of medicines and the “moral hazard” that would
otherwise arise if patients were able to obtain their medicines free of charge. In effect, patient
co-payments for medicines perform much the same role as do the “excess” payments that the
insurers of other goods and services require patients to pay when they make a claim on their
insurance policy);
those inequities are reduced to some extent by the operation of the annual safety net which
decreases the co-payment that is payable by the patient to the next lowest applicable co-payment
(e.g. once a general patient hits the annual safety net limit of $1,494.90 of total co-payments
within a year, their co-payment per script reduces from $38.80 to $6.30).
Rather, the patient co-payments:
only provide a subsidy to the patient when the cost of the script exceeds the co-payment payable
by the patient as illustrated by medicines 3 to 9 in Table 2); and
provide higher levels of assistance to those patients who require higher quantities of medicine or
have higher cost scripts (e.g. patients of the highest cost medicine 9 receive a higher levels of
assistance than patients of lower cost medicines 3 to 8).
What effect do pharmacy discounts have on the affordability of access to medicines?
The equity of access of Australians to affordable medicines is also influenced by the extent to which
pharmacies choose to discount the prices that they charge patients for those medicines.
Under current pharmacy remuneration and regulation, pharmacists are able to:
reduce the patient co-payment by up to $1 for over co-payment scripts (they can apply the “$1
discount”); and
charge patients prices that are above or below the dispensed price per script for under co-
payment scripts.
The effect that the application of the $1 discount by pharmacies has on the equity of access of
different types of patients located in different regions of Australia to affordable medicines is outlined in
Figure 8. This suggests that:
pharmacies located in urban regions of Australia (PhARIA 1) apply the $1 discount to the highest
proportions of the scripts they fill;
the more remote a pharmacy is, the lower the proportion of the scripts that it discounts using the
$1 discount; and
33
This suggests that there are significant variations in the prices that general patients actually paid per
pack of medicine in September 2016 for each of the top ten medicines by script volume.
As illustrated in Table 6, however, it is important to note that these observed differences in the prices
that patients are paying per script of medicines can come from two potential sources:
variations in the prices that pharmacies charge patients per pack for their medicines; and/or
variations in the quantities of medicine that medical practitioners prescribe per script to meet the
health needs of their patients.
Once again, this means that it is necessary to determine the extent to which these observed
differences in the prices of these top 10 medicines are due to the variations in the prices that
pharmacies are charging per pack for medicines for under co-payment scripts, as opposed to
differences in the quantities of medicine that are prescribed per script. As set out in greater detail in
Appendix 5, this involves adjusting those observed price differences for differences in the quantities of
medicines prescribed per script.
Once this correction has been made, it is apparent that 96 per cent of this observed variation in the
prices charged general patients per pack for each of these top 10 medicines in September 2016 is
due to variations in the prices that pharmacies charged for those medicines.
The frequency distributions of the prices per pack for each of these top ten medicines are provided in
Figure 9.
At this point in time, however, it is far from clear to what extent patients and their medical practitioners
are aware of these significant differences in the prices that patients actually have to pay for their
medicines. Once again, these differences in prices have potential effects on both the equity of access
of different patients to different types of medicines and the efficient use of those medicines.
It is also important to note that, since the price of generic medicines have been falling significantly
over time, it is now possible for a PBS medicine that is above the general co-payment level to be
supplied by a pharmacy through a private script at a price that is less than that co-payment. This
typically would only apply to medicines that are only priced slightly over the general co-payment level.
As a result, it is now possible for patients to have their prescriptions for certain PBS medicines filled
through private scripts at pharmacies, but it remains a business decision at pharmacy level. However,
there is currently no evidence that captures the extent to which this is occurring. It is noted that only
PBS scripts are counted towards a patient’s safety net.
35
Figure 9: Frequency distribution of the price paid by general patients in September 2016 for the each of the top 10 medicines – under co-payment scripts
Source: PBS data
36
What effect does pharmacy location have on the affordability of access to medicines?
It is also important to note that the “generalised cost” that Australians have to incur in order to access
the medicines they need does not just include the price they have to pay the pharmacist for those
medicines.
Rather the “generalised cost” that Australians have to incur also includes a range of other costs
including the:
cost of travelling to and from the pharmacy, which is estimated to be around $0.28 per km (the
Australian Transport Assessment and Planning Guidelines estimate of the vehicle operating costs
for a medium sized car operating at uninterrupted free flow speed); and
opportunity cost of time that they spend:
travelling to and from the pharmacy, which is assumed to be around $15 per hour; and
waiting for the script to be filled by the pharmacist, which is assumed to be around $2.50
(assuming an average wait of around 10 minutes and an opportunity cost of private time of
$15 per hour).
As a result, if two hypothetical patients with similar incomes and health needs face similar co-
payments for the medicines they need, the generalised costs that they incur can differ significantly
depending on how far they have to travel to visit a pharmacy. Generally, the further they have to
travel, the greater these generalised costs.
These additional generalised costs are reduced to the extent that:
pharmacies are located in those locations where Australians live, visit the medical practitioners
who prescribe their medicines, or travel to work and shop;
are open at times of the day when patients want to purchase their medicines; and
hold sufficient stocks of medicines to meet the needs of those patients who seek to purchase their
medicines from those pharmacies. It is noted that pharmacies are able to obtain medicines within
24 hours under the CSO arrangements, but this may result in additional generalised cost of
access being incurred by the patient if the patient has to visit the pharmacy again to collect the
medicine.
Despite the restrictive and complex nature of the current location rules, it is interesting to note that
pharmacies are not subject to the same types of performance contracts that Australian governments
apply to the other agents that they appoint to exclusively supply essential services on their behalf
(e.g. the providers that supply electricity, gas, water, telecommunications and some public transport
services). Those performance contracts typically outline the:
types, quantities and qualities of services that are expected to be delivered by providers to
patients over the term of the contract;
key performance indicators against which the performance of providers is assessed over the term
of the contract;
reporting requirements with which providers must comply to ensure that the government has the
information it needs to assess their performance (e.g. financial information as well as information
on types and quantities of services supplied);
37
formula that is to be used to determine the amount of remuneration that is to be paid to each
provider in return for supplying goods and services on behalf of the government;
risk sharing arrangements, which outline how financial risks and the risk of loss of continuity of
service provision are to be allocated between the government and providers, mitigated and
managed;
incentives that are to be used to encourage providers to improve their cost efficiency over time.
As a result, there is no guarantee that the pharmacy location rules will result in the establishment of a
pharmacy at a particular location that will efficiently meet the needs of those patients who might want
to purchase their medicines from that pharmacy. The size of the pharmacy that is established at a
particular location, its hours of operation, the quantity of stocks that are to be held by the pharmacy,
the efficiency with which pharmacy uses the government’s significant investment of taxpayers’ funds
is largely left up to the pharmacist to determine.
As previously noted, many Australians in theory have the option to reduce the generalised costs of
accessing the medicines they need through the use of online pharmacies. However, this is currently
constrained particularly by the need to obtain a paper script and post it to the online pharmacy.
In addition, some Australians can also reduce these generalised costs by visiting pharmacies that are
located near where they travel regularly to work or shop. However, this ability to defray those
additional costs is unlikely to be uniform across Australians. Rather, it is likely to be:
greater for those Australians who are relatively geographically mobile (e.g. younger, higher
income, working age, people who travel regularly to other regional areas to work and shop); and
lower for those Australians who are less mobile (e.g. older, unemployed, lower income, disabled,
individuals).
2.1.3 Effects of proposed changes to current arrangements on equity of access to affordable medicines and services
What effect would the removal of the ability of pharmacies to charge patients different prices for medicines have on the equity of access of Australians to affordable medicines?
The Review’s Interim Report outlines two potential options for reform that would remove the ability of
pharmacies to charge patients different prices for the medicines they supply by:
removing the ability of pharmacies to charge prices that are either below or above the dispensed
price for under co-payment scripts through the implementation Option 2.1, which states that:
Option 2.1: Pricing Variations. The payment made by any particular customer for a PBS listed
medicine should be the co-payment set by the government for that customer, or the
dispensed price for that medicine, whichever is the lower. The community pharmacy should
have no discretion to either raise or lower this price;
removing the ability of pharmacies to discount the co-payment for over co-payment scripts by up
to $1 per script through the implementation of Option 2.2, which states that:
Option 2.2: $1 Discount. The government should abolish the $1 discount on the PBS patient co-
payment.
38
The implementation of these options for reform would shift the responsibility for setting the prices that
patients are charged for their PBS medicines from pharmacies to the government.
At first sight, it might appear that such a reform would reduce the equity of access that all Australians
currently have to affordable medicines if all patients are currently receiving a net benefit from these
price variations and discounts, regardless of their location.
On closer inspection, however, an analysis of PBS data suggests that the major beneficiaries of the
current variations in the prices that pharmacies charge are those patients who purchase their
medicines from urban pharmacies (PhARIA 1), since those pharmacies:
discount the highest proportions of the scripts they fill, whereas the more remote pharmacies
discount lower proportions of the scripts they fill, as indicated in Figure 8; and
provide the highest nominal rates of assistance (reduce the prices charged by the highest
proportion). As indicated in Table 7, general under co-payment patients who purchase their
medicines from pharmacies in the urban regions of Australia (PhARIA 1) receive a nominal rate of
assistance of 9 per cent as a result of the different prices charged by pharmacies (their prices are
9 per cent lower than the dispensed price). By contrast, general under co-payment patients who
purchase their medicines from pharmacies in the more remote regions of Australia (PhARIA 3 to
6) actually have to pay more for their medicines than the dispensed price (they receive negative
nominal rates of assistance). The more remote the location of the pharmacy, the greater the
extent to which patients have to pay prices that exceed the dispensed price.
In particular, the major beneficiaries of current variations in the prices that pharmacies charge for
medicines are those patients who purchase their medicines from small and medium pharmacies
located in the urban regions of Australia (PhARIA 1), since those pharmacies provide patients with
the:
highest subsidies in dollar terms. As indicated in Table 8, general under co-payment patients who
purchase their medicines from small pharmacies located in the least remote regions of Australia
(PhARIA 1) derive a benefit of about $101m from the variations in prices charged by pharmacies.
By contrast, general under co-payment patients who purchase their medicines from pharmacies in
more remote regions of Australia (PhARIA 3 to 6) actually pay more for their medicines as a result
of the different prices charged by those pharmacies; and
highest nominal rates of assistance. As indicated in Table 9, general under co-payment patients
who purchase their medicines from small and medium pharmacies located in the urban regions of
Australia (PhARIA 1) receive nominal rates of assistance of 13 per cent and 18 per cent
respectively as a result of the variations in prices charged by those pharmacies. By contrast,
general under co-payment patients who purchase their medicines from pharmacies in more
remote regions of Australia (PhARIA 3 to 6) actually have to pay more for their medicines as a
result of the variations in the prices charged by these pharmacies.
39
Table 7: Effect of price variations on the prices of medicines to patients by location of pharmacy (general under co-payment scripts only)
Source: PBS data Notes:
* Equals the sum of the dispensed price for scripts filled. ** Excludes price differences caused by Brand premiums, Therapeutic group premiums, Special patient contributions and the $1 discount. *** Positive nominal rates of assistance indicate the patients paid less than the dispensed price and vice versa for the negative nominal rate of assistance. 1. Only pharmacies with approval number as at March 2015 are included, see note 5 of Table 8 below. 2. Price variation and PBS Patient Contribution are extracted from PBS data from 01/01/2016 to 31/12/2016.
3. Chemotherapy drugs are excluded. 4. Includes general non-safety net under co-payment patients only. 5. The data may contain minor unadjusted price variations that are not attributable to pricing discretion at
pharmacy level. 6. See Appendix 5 for outline of methodology used.
Table 8: Effect of price variations* on the prices of medicines to patients by pharmacy size and location (general under co-payment scripts only)
Source: PBS data Notes:
* Excludes price differences caused by Brand premiums, Therapeutic group premiums, Special patient contributions and the $1 discount. 1. Pharmacies have been classified into the various categories of pharmacies using their PBS revenue with
the assumption that this comprises 80% of their revenue. 2. Negative price variation means patients have paid less.
3. Chemotherapy drugs are excluded. 4. Includes general non-safety net under co-payment patients only. 5. Includes only pharmacies that traded for the full 2016 calendar year to avoid larger pharmacies trading part
year to be included in smaller pharmacy size categories. 6. The data may contain minor unadjusted price variations that are not attributable to pricing discretion at
pharmacy level, such as differences in the quantities of medicines dispensed. 7. See Appendix 5 for outline of methodology used.
1 $1,063,669,635 -$94,080,686 9%
2 $34,769,640 $192,196 -1%
3 $45,443,307 $5,851,184 -13%
4 $14,932,988 $2,606,211 -17%
5 $16,820,761 $3,917,202 -23%
6 $7,561,046 $2,368,720 -31%
PhARIA
Accumulated
consumer
contribution*
Accumulated price
variation**
Nominal rate of
assistance*** to
consumers
(arising from price
variations)
Micro Small Medium Large Very Large
1 12,993,129 -100,888,490 -3,936,770 495,187 -166,934 -91,503,878
2 777,035 -646,831 130,204
3 2,086,603 3,672,055 5,758,658
4 1,317,681 1,264,183 2,581,864
5 1,929,921 1,951,371 3,881,292
6 1,900,114 453,932 2,354,046
Total 21,004,483 -94,193,780 -3,936,770 495,187 -166,934 -76,797,814
PhARIAPharmacy size
Total
40
Table 9: Effect of price variations* on the nominal rates of assistance** provided to patients by pharmacy type and location (general under co-payment scripts only)
Source: PBS data Notes:
* Excludes price differences caused by Brand premiums, Therapeutic group premiums, Special patient contributions and the $1 discount.
** Positive nominal rates of assistance indicate the patients paid less than the dispensed price and vice versa for the negative nominal rate of assistance. 1. Pharmacies have been classified into the various categories of pharmacies using their PBS revenue with
the assumption that this comprises 80% of their revenue. See appendix 2 for the methodology used. 2. Includes general non-safety net under co-payment patients only. 3. The data may contain minor unadjusted price variations that are not attributable to pricing discretion at
pharmacy level. 4. See appendix 5 for outline of methodology used.
Table 10 provides information on the types of patients that derive the greatest net benefits from
variations in the prices charged by pharmacies and the application of the $1 discount. In particular, it
suggests that overall:
“general under co-payment patients” receive the greatest net savings from differences in the
prices that pharmacists charge patients for their medicines;
“concessional patients” receive the greatest benefit from the $1 discount.
This suggests that rather than improve the equity of access that Australians resident in the more
remote regions of Australia have to affordable medicines, the current differences in the prices charged
by pharmacies and the $1 discount arrangements actually have the unintended effect of reducing the
overall equity of access by further improving the relative equity of access that those Australians
resident in metropolitan areas have to affordable medicines.
As a result, the removal of these price variations and the $1 discount has the potential to improve the
overall equity of access to affordable medicines across Australia, albeit by making medicines more
expensive in metropolitan areas. Such a reform is, in effect, equivalent to a decision to improve the
overall equity of access to affordable medicines by removing the additional benefits that residents of
metropolitan regions of Australia derive from the current discounts.
As indicated in Table 10, assuming all else being equal, the removal of existing price variations and
the $1 discount would cost Australian patients around $153m per annum with around:
$97.8m of that cost being born by “general under co-payment” patients; and
$49.9m of that cost being born by “concessional” patients.
If the premise of holding all else equal is continued it may be assumed that the cost to patients above
would translate to benefits to pharmacies.
Micro Small Medium Large Very Large
1 -6% 13% 18% -10% 8%
2 -12% 2%
3 -17% -12%
4 -18% -18%
5 -23% -26%
6 -32% -31%
PhARIAPharmacy size
41
Table 10: Overall combined effect of price variations and the $1 discount on the prices paid by patients by type of patient (2016 calendar year)
Source: PBS data Notes:
* Excludes price differences caused by brand premiums, therapeutic group premiums, special patient contributions and the $1 discount. Positive variation means the patients paid more than the dispensed price or co-payment and negative price variation means the patients paid less. ** Negative saving means that patients paid more than they would have paid in the absence if price variation. 1. Negative price variation and positive dollar discount means patients have paid less.
2. Negative price variation comes in the form of discount on the dispensed price and does not include the $1 discount.
3. Chemotherapy drugs excluded. 4. Discussions around costs or savings to patients if pricing variation or the $1 discount is removed assumes
that pricing will be kept at current dispensed price or co-payment levels and all else being held equal. 5. Although price variations are not expected for concessional, general safety net and general over co-payment
scripts, some variations were found that are likely to be due to quantity variations at script level rather than pharmacy discretionary pricing. These observations do not alter the results of the analysis.
6. See Appendix 5 for outline of methodology used.
What effect would the removal of pharmacy location regulations have on the equity of access of Australians to affordable medicines?
Another potential option for the reform of current pharmacy regulations identified in the Review’s
Interim Report is the removal of the current regulations governing pharmacy location through the
implementation of Option 5.1 which states that:
Option 5.1: Location Rules – Removal and Replacement. The government should remove the
location rules for community pharmacies. It should replace the location rules with one of the
alternatives presented below (as outlined in Option 5.2 and Option 5.3).
Some indication of the potential effect that this is likely to have on the equity of access of Australians
to affordable medicines can be obtained from an analysis of
data on rejections of applications for new and relocated pharmacies. It has been assumed that
following the removal of the location rules, rejected applicants would proceed with those
developments.
Using the application rejection rate data set out in Table 11, the removal of the current constraints
imposed on pharmacy location are likely to generate the greatest improvements in the equity of
access to affordable medicines for the residents of the:
major cities, inner and outer regional areas of Australia, which have experienced the highest
rejection rates for new pharmacy applications ( ); and
outer regional areas of Australia, which have the highest rejection rates for relocated pharmacies
( ).
Sum of positive
variation
Sum of negative
variation
Concessional Safety Net $0 $0 $0 $0 $0
Concessional $1,959,664 -$3,687,005 $1,727,341 $48,178,138 $49,905,479
General Safety net $81,053 -$5,502 -$75,551 $501,024 $425,473
General (over co-payment) $291,157 -$1,728,403 $1,437,246 $3,287,724 $4,724,970
General (under co-payment) $143,238,137 -$241,123,864 $97,885,727 $0 $97,885,727
Grand Total $145,570,011 -$246,544,774 $100,974,763 $51,966,886 $152,941,649
Consumer Type
Variation in actual price paid from
Commonwealth dispensed price or co-payment, Net saving to
consumers from
price variation**
Sum of $1 Discount
Combined impact
of price variations
and $1 discount
42
Table 11: Geographic distribution of applications to establish new, and relocate existing, pharmacies (financial year 2015-16)
Source:
What effect would the greater use of electronic prescriptions have on the equity of access of Australians to affordable medicines?
Another potential option for reform identified in the Review’s Interim Report is to facilitate the
increased, integrated, use of electronic prescriptions in order to replace the current, less efficient,
paper based scripts through the implementation of Option 2.7, which states that:
Option 2.7: Electronic Prescriptions. The government should initiate an appropriate system for
integrated electronic prescriptions and medicine records as a matter of urgency. Under this
system the electronic record should become the legal record. Participation in the system
should be required for any prescriber of a PBS listed medicine, pharmacist wishing to
dispense a PBS listed medicine, and any patient who is seeking to fill a PBS prescription;
As noted in section 2.1.2, the current predominantly paper based system of prescriptions potentially:
inhibits the increased use of online pharmacies;
increases the generalised cost that patients have to incur in order to access the medicines they
need; and
thereby reduces the equity of access of the more remote regions of Australia to the medicines
they need, particularly the less mobile residents of those regions who do not have to travel into
cities to work or to shop.
As a result, facilitating the increased use of electronic prescriptions has the potential to improve the
equity of access of Australians to affordable medicines, particularly the less mobile residents of those
more remote regions of Australians who would otherwise have to travel relatively long distances to
visit their nearest pharmacy. For example, if a patient would otherwise have to travel 100 km (50km
each way) to visit the nearest pharmacy to have a script filled, their ability to order their medicines
online would result in a:
$28 reduction in road transport costs (for a 100km round trip that costs $0.28 per km);
$15 reduction in travel time (assuming an average speed of 100km per hour); and
Approved RejectedRejection
rate
Major Cities of Australia
Inner Regional Australia
Outer Regional Australia
Remote Australia
Very Remote Australia
Total New Australia
Major Cities of Australia
Inner Regional Australia
Outer Regional Australia
N/A
Total Relocated Australia
Total Application Australia
Type of application Remoteness of proposed pharmacy
Total number
of
applications
Outcome of application
New
Relocated
43
$2.50 reduction in time waiting for the script to be filled (assuming a wait time of 10 minutes that
has an opportunity cost of $15 per hour of private time).
These total cost reductions of $45.50 would, of course be offset by the:
opportunity cost of the time that the patient spends ordering the medicine online, which is
assumed to be around $2.50 (it is assumed for the purposes of this simple example that the
patient spends 10 minutes of their private time, which has an opportunity cost of $15 per hour);
shipping costs charged by the online pharmacy for the delivery of the medicine, which are
assumed to be $8.95; and
opportunity cost of having to wait for the medicines to be delivered by the online pharmacy. For
the purposes of this simple example, it is assumed that these costs are zero (it is assumed that
these medicines are not urgent, are not heat sensitive and little value is lost having to wait for the
delivery of these medicines).
Overall, in this case, the cost to the patient would be reduced by around $34.05 for each script they
purchase online, which is around 88 per cent of the price they have to pay for that medicine
(assuming that they pay the general co-payment of $38.80 for that medicine).
This highlights the significant magnitude of the cost reductions that patients could derive from
purchasing their medicines online, rather than incurring the additional costs associated with visiting
the pharmacy in person.
2.2 Equity of remuneration arrangements for pharmacies
2.2.1 Intended effects of the current remuneration arrangements
Another key objective of the current remuneration arrangements is to ensure that pharmacies and
wholesalers receive equitable access to sufficient remuneration to compensate them for the costs of
supplying medicines on behalf of the government.
If pharmacies and wholesalers are not equitably compensated for the cost of supplying medicines on
behalf of the government, there is a risk that this will reduce the access that some Australians in
particular regional areas have to affordable medicines.
It is important to note, however, that this does not mean that all existing pharmacies and wholesalers
should be compensated for the actual average costs that they incur in order to supply medicines on
behalf of the government. The current pharmacy and wholesaler remuneration arrangements are not
intended to ensure the profitability of existing suppliers.
Rather, it means that pharmacies and wholesalers need to receive sufficient remuneration to
compensate them for the efficient long run marginal costs of supplying those medicines.
2.2.2 Actual effects of current remuneration arrangements
What information is available on the efficient costs of supplying medicines?
In order to be able to assess the extent to which the current remuneration arrangements are
achieving their intended objective of compensating pharmacies for the efficient costs of supplying
those medicines, it is necessary to have information on the efficient costs of supplying those
medicines.
As illustrated in Figure 10, this requires the government to obtain detailed information on the:
44
types and quantities of medicines that pharmacies are expected to supply on behalf of the
government;
types and quantities of inputs that pharmacists need to purchase to supply medicines and
services on behalf of the government, which also requires detailed information on the way in
which pharmacists will combine these inputs to supply their outputs of medicines (the “business
model” or “production technology” employed by the pharmacist). These key inputs include:
pharmaceuticals purchased from wholesalers;
buildings and other capital equipment; and
a wide range of other inputs;
efficient costs of purchasing those inputs, which requires detailed information on the “arms-length”
prices of those inputs (the market prices of those inputs that prevail in markets where those inputs
are traded in large volumes in competitive markets between unrelated parties);
types and quantities of capital that pharmacists invest in their businesses, which include:
injections of equity by the owners of the business;
buildings, fit out and other capital equipment owned by the business;
trading stock; and
goodwill;
efficient cost of that capital, which is the rate of return that is sufficient to compensate pharmacies
for the efficient cost of the capital they use to supply medicines on behalf of the government,
which includes both a:
return on investment (ROI) that is sufficient to compensate the owners of that capital for the
“opportunity cost” of that capital (the rate of return they could have earned by investing that
capital in the next best investment). Typically, this required ROI is estimated by calculating the
weighted average cost of capital for the business (WACC) using a capital asset pricing model
(CAPM); and
return of capital (ROC) that is sufficient to compensate the owners of that capital for any
capital that is used up in the course of supplying medicines on behalf of the government (to
compensate them for the annual economic depreciation in value of the assets they use to
supply those medicines);
This information is then used to calculate the efficient long run marginal costs of supplying each of the
goods and services that pharmacies are contracted to supply on behalf of the government (the
“incremental” efficient costs that pharmacies would incur in order to supply those medicines).
This is the same rigorous approach that is used extensively by the government to determine the
amount of revenue that should be provided to the suppliers of other essential services (e.g. public
transport, electricity, gas and telecommunication services) to compensate them for the efficient costs
of supplying those services.
45
Figure 10: Information required to determine the efficient cost of dispensing
Source: RSM
However, this is not the approach that has been used to date to determine the remuneration that
should be provided to pharmacies to compensate them for the efficient costs of supplying medicines
on behalf of the government. Although pharmacies are currently paid different fees for supplying
different types of medicines, those fees have not been estimating using information on the efficient
costs of supplying those medicines. Rather, those current fees are more a reflection of historical
precedent, as modified by successive rounds of negotiation between the Pharmacy Guild and the
government.
As a result, there is relatively little information available on the efficient costs of a pharmacy supplying
medicines on behalf of the government. Indeed, the only information that has been provided to the
Review on the efficient costs of pharmacies supplying medicines is that supplied by Mr Bruce
Annabel, which seeks to identify the costs incurred by a “best practice” pharmacy. The Department
46
would like to thank Mr Annabel for his advice regarding the revenues and costs incurred by
pharmacies in Australia.
Most of the information that has been provided to the Review relates to the average revenue and
costs that pharmacies actually derive and incur from supplying all of the goods and services they sell,
as opposed to the efficient marginal costs of supplying medicines and related costs on behalf of the
government.
In particular, it is important to note that the available average cost data covers pharmacies that differ
significantly in their:
size (total sales revenue);
proportion of total sales revenue that they derive from the supply of PBS medicines, as opposed
to non-PBS goods and services;
different business models used by pharmacies to combine their inputs to produce the medicines
they supply on behalf of the government (differences in the “production technologies” employed
by pharmacies with different business models, such as discount pharmacies as opposed to more
traditional pharmacy models);
business structure (sole trader, company, partnership, trust, friendly society);
taxable status (e.g. taxable entities as opposed to non-taxable entities, such as non-taxable
companies that are set up as friendly societies); and
profitability (profitable and non-profitable pharmacies).
As a result, simple averages across all pharmacies of the costs that pharmacies incur in order to
supply all of the goods and services they supply are unlikely to provide an accurate indication of either
the:
actual average costs incurred by different types of pharmacies; or
efficient long run marginal costs of supplying those medicines on behalf of the government.
Another major challenge regarding the data currently available to the Review is that it is not available
from a single, consistent, source. Rather, it is spread across a range of different sources, including
the:
data provided ;
PBS data on the amount of remuneration that each pharmacy received from the government for
their supplies of medicines;
data on the capital that pharmacies invest in their businesses;
Pharmacy Guild Digest survey data on independent pharmacy operations in Australia;
data;
data sourced from Benchmarking.com.au, which provides financial benchmarking data for the
2016 financial year on pharmacies and a range of other similar retail businesses (e.g. corner
stores, health food retailers, medical practices and supermarkets); and
data sourced from the financial survey conducted by the Review.
47
As a result, in order to assist the Review to determine the equity of current remuneration
arrangements, a financial model has been developed that seeks to make the best possible use of
these available data sources in order to provide a more comprehensive overview than is currently
provided by any one of these current data sources.
In particular, since there are significant differences between the size, financial performance and
taxable status of pharmacies, those pharmacies have been classified into a number of different
categories based on their:
total sales revenue and composition of sales revenue (the financial model enables us to alter the
proportion of revenue that type of pharmacy derives from the supply of PBS medicines on behalf
of the government in relation to the revenue they derive from the sale of other non-PBS goods
and services. The five different sizes of pharmacies have been selected for detailed financial
analysis are:
“micro” pharmacies, which have an annual turnover of less than $2m;
“small” pharmacies, which have an annual turnover between $2m and less than $10m;
“medium” pharmacies, which have an annual turnover between $10m and less than $20m;
“large” pharmacies, which has an annual turnover between $20m and less than $40m; and
“very large” pharmacies, which have an annual turnover of $40m or more;
profitability:
“profitable” pharmacies (pharmacies reporting a tax profit);
“not profitable” pharmacies (pharmacies reporting a tax loss);
taxable status:
taxable pharmacies; and
“non-taxable” pharmacies (e.g. pharmacies operating as non-taxable friendly societies);.
This taxonomy produces up to 15 different categories of pharmacies for detailed financial analysis:
5 different sizes of profitable, taxable pharmacies, which includes all pharmacies operating as
taxable sole traders, companies, partnerships and trusts;
5 different sizes of profitable, non-taxable pharmacies; and
5 different sizes of non-profitable pharmacies.
Having identified these different classes of pharmacies:
was used to determine the average total revenue that pharmacies in each of these
categories derive; and
data was used to determine the capital that each of these categories of
pharmacies have invested to produce the goods and services they supply;
48
Benchmarking and Pharmacy Guild data was used to determine the:
average proportion of total revenue that each of these categories of pharmacies derive from
the supply of PBS and non-PBS goods and services;
composition of costs incurred by pharmacies; and
manner in which costs change in response to changes in the sales mix of pharmacies (as the
ratio of the value PBS to non-PBS sales changes);
PBS data was used to determine the:
total PBS revenue derived by each pharmacy in each of those categories;
total number of pharmacies in each of the categories; and
location of each of the pharmacies in each of those categories. As discussed further in section
3.2 below, this then enables us to estimate the impact of changes in the current pharmacy
remuneration structure and fees on these categories of pharmacy by regional area of
Australia.
A summary of the various sources of financial data is provided in Table 12 below, which shows the
extent to which the estimated revenues and costs differ across the various sources of data as
indicated by the maximum and minimum values.
A more detailed outline and comparison of these various sources of financial data is provided in
Appendix 2.
49
Table 12: Summary of pharmacy financial data available
Source: Data outlined in Appendix 2
Notes:
1. AOS: After owners’ salary.2. Return on capital includes $0.1 for working capital and a 10% margin to allow for a return on capital. 3. Blank fields indicate areas where no data was available. 4. Excludes data from financial survey responses due to range extremities.
Range
Min
Range
Max
Model
Profitable
Range
Min
Range
Max
Model
Profitable
Range
Min
Range
Max
Model
Profitable
Range
Min
Range
Max
Model
Profitable
Range
Min
Range
Max
Model
Profitable
SALES
COST OF GOODS SOLD 55% 67% 61% 58% 64% 62% 66% 80% 80% 86% 87% 86% 88% 88% 88%
GROSS MARGIN 33% 45% 39% 36% 41% 38% 20% 34% 20% 13% 14% 14% 12% 12% 12%
Less owners salary 8% 18% 9% 1% 3% 3% 1% 1% 1% 1% 1% 1% 0.4% 0.4% 0.4%
TOTAL EXPENSES (aos*) 26% 57% 26% 27% 44% 27% 14% 36% 14% 6% 7% 7% 5% 5% 5%
NET PROFIT/LOSS (aos*) -21% 13% 13% -4% 9% 11% -2% 6% 6% -7% 7% 7% 2% 2% 2%
EBITDA (aos*) -17% 16% 17% -1% 14% 13% 0% 8% 8% -5% 9% 9% 4% 4% 4%
SALES ANALYSIS
Prescriptions 66% 77% 73% 61% 77%
Other Sales 23% 27% 30% 39%
STATISTICSDISPENSING REVENUE/SCRIPT 10.00 28.03 11.25 10.00 28.03 11.28 10.00 28.03 11.63 10.00 28.03 13.63
COST PER DISPENSE 5.96 - 11.12 7.67 9.00 5.96 - 11.12 5.96 - 11.12 5.96 - 11.12
COST PER DISPENSE
(INCLUDING RETURN ON
CAPITAL)
6.66 - 12.33 8.57 10.00 6.66 - 12.33 6.66 - 12.33 6.66 - 12.33
NET ASSETS 85% 85% 85% 79% 85% 82% 79% 79% 79% 59% 59% 59% 50% 50% 50%
Very Large ($40m+)
Item
Micro ($0-$2m) Small ($2-$10m) Medium ($10-$20m) Large ($20-$40m)
50
Are pharmacies earning economic rents?
A potential misconception regarding pharmacies is that they are earning economic rents due to the
regulatory constraints that are imposed on the ownership and location of pharmacies.
As previously noted, the most comprehensive data currently available on the profitability of
pharmacies is that provided .
As illustrated in Table 13, the data provides little evidence to suggest that these 15
categories of pharmacies are, on average, earning economic rents.
Rather, as indicated in Table 14, it suggests that 15.4 per cent of all pharmacies are not generating
taxable profits. Specifically:
11 per cent of all pharmacies are micro pharmacies and are not earning taxable profits. This is
explained to some extent by the effect of the significant small business tax concessions provided
to such businesses, which would be more than sufficient to turn any relatively small pre-tax profit
they derive into a post-tax loss;
4 per cent of all pharmacies are small pharmacies and are not earning taxable profits;
0.3 per cent of all pharmacies are medium pharmacies and are not earning taxable profits; and
0.1 per cent of all pharmacies are large pharmacies and are not earning taxable profits.
Of the 84.6 percent of pharmacies generating profits, profits increase as the size of the business
increases as follows:
“very large” pharmacies which comprise 0.1 per cent of all pharmacies, derived $1m net profit on
average in 2013-14. These are the largest pharmacies, which generate $40m and over of annual
turnover and are non-taxable, since they operate as friendly societies;
“large” pharmacies, which comprise 3.6 per cent of all pharmacies derived $1.8m net profit on
average in 2013-14. These are the second largest pharmacies, which generate between $20m
and less than $40m of annual turnover;
“medium” pharmacies, which comprise 0.2 per cent of all pharmacies derived $0.9m net profit on
average in 2013-14. These are the third largest pharmacies, which generate between $10m and
less than $20m of annual turnover;
“small” pharmacies, which comprise 33.9 per cent of all pharmacies derived $0.4m (for profitable
taxable pharmacies) and $0.1m (for profitable non-taxable pharmacies) net profit in 2013-14.
These are the fourth largest pharmacies, which generate between $2m and less than $10m of
annual turnover;
“micro” pharmacies, which comprise 46.8 per cent of all pharmacies derived $0.09m (for profitable
taxable pharmacies) and $0.03m (for profitable non-taxable pharmacies). These are the smallest
pharmacies, which generate less than $2m of annual turnover.
In addition, there is little evidence to suggest that pharmacies are, on average, earning economic
rents (rates of return higher than normal rates of return on their capital). On the contrary, as indicated
in Table 13, the return that profitable pharmacies are earning on their capital ranges up to 15 per cent.
51
The profitable pharmacies that are earning the highest rates of return on their capital investments are,
in declining order:
“micro” pharmacies which are earning an average nominal rate of return on capital of 15 per cent
per annum;
“large” pharmacies, which are earning an average nominal rate of return of 13 per cent per
annum; and
“small” pharmacies which are earning an average nominal rate of return on capital of 10 per cent
per annum;
“medium” pharmacies, which are earning an average nominal rate of return of 8 per cent per
annum.
At first sight, these results might seem to be counter intuitive. If current pharmacy location and
ownership regulations are restricting the competition faced by pharmacies in the markets for their
outputs, inputs and factors of production, why aren’t they earning economic rents?
On closer inspection, it appears that there is enough competition between pharmacists looking to
purchase an existing pharmacy or establish a new pharmacy under the location rules, to capitalise the
value of any short term economic rents into asset values in the longer term (e.g. into the higher prices
that pharmacists must pay for the rental of their premises and the goodwill of the businesses they
purchase). This creates long term inefficiencies in the use of the nation’s scarce resources and is
further outlined in section 3.2.
52
Table 13: Pharmacy profitability and rates of return on capital
Source: data and data
Table 14: Proportion of pharmacies in each category
Source:
Micro
Small
Medium
Large
Very Large
Total Profitable
Micro
Small
Medium
Large
Total Not Profitable
TOTAL Total Pharmacies
Not Profitable
Profitability status Pharmacy size Proportion
Profitable
53
How equitable are the current pharmacy remuneration arrangements?
Ideally, the way in which pharmacies are remunerated should be equitable across pharmacies.
Pharmacies supplying exactly the same types and quantities of medicines should receive the same
level of remuneration from the government for the efficient costs of supplying those medicines.
It is important to note that the actual equity with which pharmacies are remunerated for the costs of
supplying medicines on behalf of the government is affected by a wide range of factors, not all of
which are within the scope of the Review. These factors include the:
prices that pharmaceutical manufacturers charge for the pharmaceuticals they supply, which are
influenced by the outcome of negotiations between the government and manufacturers, or market
discounting behaviour in the case of generics; These factors and are outside the scope of the
Review;
prices that wholesalers charge for the pharmaceuticals they supply, which are within the scope of
the Review;
co-payments that patients are required to pay to pharmacies for the medicines they purchase,
which are set by the PBS and are outside the scope of the Review; and
remuneration that is provided to pharmacies to compensate them for the costs of purchasing,
storing and dispensing those medicines, which are the central focus of the Review.
What effect do the PBS co-payment limits have on the equity of pharmacy remuneration?
As noted in section 2.1.2, the caps that are currently imposed by the PBS on patient co-payments are
achieving their intended objectives of improving the equity of access to affordable medicines to the
extent that they provide greater levels of assistance to patients with lower incomes and greater health
needs.
It is important to note, however, that the subsidies provided to patients do not have a uniform effect on
pharmacies. Rather, patient subsidies may favour those pharmacies that supply greater quantities of
medicines to patients that receive the highest subsidies. For example, the current PBS arrangements
may tend to favour those pharmacies that supply a greater proportion of their medicines to
concessional safety net patients, as opposed to general patients. It is noted that prescribers play a
vital role in the levels of demand for PBS medicines.
Although some pharmacists might consider this to be inequitable (for example, those who have not
been able to locate their pharmacy in an area that is frequented by large numbers of highly subsidised
patients), this effect is an inevitable consequence of the government’s decisions to:
provide assistance only to particular types of patients and medicines; and
restrict the location of pharmacies.
54
What effect does the payment of a single dispensing fee have on the equity of pharmacy
remuneration?
Since the current remuneration arrangements for pharmacies are not based on the results of a
rigorous analysis of the efficient costs of supplying those medicines, it is likely that those
remuneration arrangements may either over-remunerate or under-remunerate pharmacies for those
efficient costs.
To illustrate this point, Table 15 presents a hypothetical example showing how the current pharmacy
remuneration arrangements may have an adverse effect on the equity with which pharmacies are
remunerated if pharmacists are paid the same fee of $11.50 per script for performing a range of
different dispensing activities. Activities 1 to 9 each represent a different medicine of the same value
being dispensed but each dispense requires a different level of effort by the pharmacist. Specifically
activities 1 to 9 range from:
relatively high economic value adding activities, such as Activity 1, which involves the pharmacist
adding the highest value ($11.50 per script) to the cost of the medicines and other inputs they use
(e.g. dispensing activities that require the pharmacist to perform more complex and time
consuming tasks, including consultation with the prescriber, and the provision of more complex
advice to the patient on the appropriate use of the medicines);
through to relatively low economic value adding activities, such as Activity 9, which involves the
pharmacist adding the lowest amount of value to the cost of the medicines and other inputs they
use (e.g. dispensing activities such as labelling pre-packaged medicines, which may require less
skill by the pharmacist compared to the more complex dispensing activities outline above).
This appears to have the effect of reducing the equity of pharmacy remuneration arrangements by
providing:
lower rates of assistance to the more efficient pharmacies that add greater value to the inputs
they purchase to supply medicines and services on behalf of the government. In particular, the
payment of a single dispensing fee per script:
provides pharmacists with a level of assistance that decreases as the value added by the
pharmacist increases (e.g. activity 1, which involves the pharmacist adding the most value to
the costs of the inputs used, receives the lowest effective rate of assistance. This effective
rate of assistance measures the extent to which the remuneration arrangements for
dispensing proportionally change the returns that the pharmacist receives to compensate
them for that value adding activity. A negative effective rate of assistance indicates that the
pharmacist is under-remunerated for the efficient costs of performing that value adding
activity);
provides negative effective rates of assistance to those activities that involve the pharmacist
incurring efficient costs that are higher than the dispensing fee they are paid by the
government (e.g. activities 1 to 4 receive a negative effective rate of assistance, which
indicates that pharmacists are under-remunerated for the efficient costs of performing those
activities. That is, the remuneration arrangements, in effect, impose a tax of those
pharmacists that perform those activities and the magnitude of that tax increases the greater
the value they add to the cost of their inputs);
higher rates of assistance to less efficient pharmacies that add less value to the inputs they
purchase to perform their activities on behalf of the government. In particular, the payment of a
single dispensing fee per script:
55
provides pharmacists with a level of assistance that increases as the value added by the
pharmacist decreases (e.g. activity 9, which involves the pharmacist adding the least value to
the costs of the inputs used, receives the highest effective rate of assistance. A positive
effective rate of assistance indicates that the pharmacist is over-remunerated for the efficient
costs of performing that value adding activity);
provides positive effective rates of assistance to those activities that involve the pharmacist
incurring efficient costs that are lower than the dispensing fee they are paid by the
government (e.g. activities 6 to 9 receive a positive effective rate of assistance, which
indicates that pharmacists are over-remunerated for the efficient costs of performing those
activities. That is, the remuneration arrangements, in effect, provide a subsidy to those
pharmacists that perform those activities and the magnitude of that subsidy is greater the
lower the value they add to the cost of their inputs).
This is the reason why the current pharmacy remuneration arrangements seek to identify the different
value adding activities performed by pharmacies on behalf of the government and pay them different
fees for each of those activities that reflect the efficient costs of performing those activities. However,
it is inevitable that:
pharmacies will be over-remunerated for the efficient costs of performing some activities and
under-compensated for the efficient costs of performing other activities; and
pharmacies will have to use the additional revenue they derive from performing their most
profitable activities to cross subsidise the costs of having to perform their less profitable activities.
However, the ability of pharmacies to cross subsidise their activities is unlikely to be uniform
across all types of pharmacies. In particular, the smallest, micro pharmacies are likely to have the
least scope to cross subsidise their activities in the face of mounting competition and price
pressures; and
these cross subsidisation activities of pharmacies are unlikely to have a uniform effect on the
prices that they charge patients for the medicines they supply. Rather, they are likely to have
complex effects on the relative prices that they charge patients for the PBS and non-PBS goods
and services they supply, that in turn, may have adverse effects on the:
equity of funding received by different types of pharmacies;
affordability of access that some Australians have to particular types of medicines; and
efficiency with which medicines are used, which is discussed further in section 3.1.
What is the overall effect of current arrangements on the equity of pharmacy remuneration?
As previously noted, it is difficult to assess the equity of current pharmacy remuneration arrangements
in the absence of detailed information on the efficient costs of pharmacies suppling medicines on
behalf of the government.
Rather, in the absence of that information, it is necessary to rely instead on the limited information
that is currently available on the average costs that pharmacies are currently incurring in order to
supply medicines on behalf of the government.
Some indication of the overall effect of the PBS and current remuneration arrangements for
pharmaceutical manufacturers, wholesalers, and pharmacies on the financial position of pharmacies
is provided in Table 16, which provides estimates of the “effective rates of assistance” provided to
56
each of the different types of pharmacies considered by the current pharmacy remuneration and
regulation.
The “effective rate of assistance” measures the net effect of:
assistance provided to the goods and services supplied by pharmacy (e.g. the subsidies that are
provided by the PBS to patients of the medicines supplied by pharmacies); and
assistance provided to the inputs used by pharmacies to supply medicines (e.g. the remuneration
provided by the government to compensate pharmacies for the costs of purchasing the
pharmaceuticals and other inputs they need to supply medicines on behalf of the government).
As noted by the Industry Commission, there are several alternative, but equivalent, methodologies
that can be employed in order to estimate the effective rates of assistance that particular forms of
government intervention provide to the performance of economic activities.4
For the purposes of this report, the effective rate of assistance provided to different types of
pharmacies have been estimated by:
estimating the extent to which the current pharmacy remuneration arrangements changes the
amount of value added by each pharmacy to the cost of their inputs. This change in value added
is estimated by taking the difference between the:
assisted value added by each type of pharmacy in the presence of government assistance,
which is estimated by taking the difference between the:
− assisted value of output of each type of pharmacy (in the presence of government
assistance);
− assisted value of inputs of each type of pharmacy (in the presence of government
assistance;
assisted value added by each type of pharmacy in the absence of government assistance,
which is estimated by taking the difference between the:
− unassisted value of output of each type of pharmacy (in the absence of government
assistance); and
− unassisted value of inputs of each type of pharmacy (in the absence of government
assistance. As noted above, this is equal to the assisted value of inputs, since the key
focus of the analysis is on estimating the extent to which the combined effects of the
subsidy to patients and the current remuneration arrangements have on the level of
assistance provided to the dispensing activities of pharmacies;
expressing that change in value added as a proportion of the unassisted value added by the
pharmacy.
The resultant “effective rate of assistance” indicates the extent to which government assistance to
pharmacies increases or decreases the returns that the pharmacy derives from performing their value
adding activities:
a positive effective rate of assistance indicates that government assistance has increased the rate
of return that the pharmacy has derived from its value adding activities (it has over-compensated
the pharmacy for the costs of performing those value adding activities);
4 Industry Commission (1992). The Measurement of Effective Rates of Assistance in Australia, Industry Commission Working Paper No.4 , http://www.pc.gov.au/research/supporting/measurement-effective-rates-assistance
57
a negative effective rate of assistance indicates that government assistance has reduced the
return that the pharmacy has derived from its value adding activities (it has under-compensated
the pharmacy for the costs of performing its value adding activities); and
a zero effective rate of assistance indicates that government assistance has had no effect on the
rate of return that the pharmacy has derived from its value adding activities (it has compensated
the pharmacist for the costs of supplying medicines).
58
Table 15: Illustration of the effect that paying pharmacies the same fee for performing different types of activities has on effective rates of assistance provided to pharmacies
Source: RSM
Notes:
1. The content of this table is hypothetical and is used to illustrate the effect that paying a single flat fee for dispensing may have on the equity of pharmacy remuneration. 2. All values in this table are notional except the co-payment value of $38.80. 3. Unassisted value added (UVA) is equal to the unassisted value of output (UVO) less the unassisted value of inputs (cost of medicine and other inputs).
4. Assisted value added (AVA) is equal to the assisted value of output (AVO) less the assisted value of inputs, which is assumed to be the same as the unassisted value of inputs.
5. Unassisted value of outputs (UVO) is the value of outputs before government subsidy. 6. Assisted value of outputs (AVO) is the value of outputs after government subsidy. 7. Activity 1 represents a high value adding activity, for example, a complex dispense. 8. Activity 9 represents a low value adding activity, such as a simple dispense.
Cost of
medicine to
pharmacy
Cost of
other
inputs
Unassisted
value added
by
dispensing
(UVA)
Unassisted
value of
output
(UVO)
Government
remuneration
for cost of
medicine
Co-payment by
consumer
Financial
profit (loss)
Cost of
medicine to
pharmacy
Cost of
other inputs
Unassisted
value added
by
dispensing
(UVA)
Government
remuneration
for cost of
medicine
Co-payment by
consumer
Dispensing
fee from
Government
Assisted
value added
by
dispensing
(AVA)
Assisted
value of
output (AVO)
Financial
gain (loss)
(AVA-UVA)
ERA with a $11.50
dispensing fee (AVA-
UVA)/UVA
ERA with a $10.00
dispensing fee (AVA-
UVA)/UVA
Activity 1 $100.00 $2.00 $11.50 $113.50 $61.20 $38.80 -$13.50 $100.00 $2.00 $11.50 $61.20 $38.80 $11.50 $9.50 $111.50 -$2.00 -17.3% -30.4%
Activity 2 $100.00 $2.00 $11.00 $113.00 $61.20 $38.80 -$13.00 $100.00 $2.00 $11.00 $61.20 $38.80 $11.50 $9.50 $111.50 -$1.50 -13.5% -27.3%
Activity 3 $100.00 $2.00 $10.50 $112.50 $61.20 $38.80 -$12.50 $100.00 $2.00 $10.50 $61.20 $38.80 $11.50 $9.50 $111.50 -$1.00 -9.4% -23.8%
Activity 4 $100.00 $2.00 $10.00 $112.00 $61.20 $38.80 -$12.00 $100.00 $2.00 $10.00 $61.20 $38.80 $11.50 $9.50 $111.50 -$0.50 -4.9% -20.0%
Activity 5 $100.00 $2.00 $9.51 $111.51 $61.20 $38.80 -$11.51 $100.00 $2.00 $9.51 $61.20 $38.80 $11.50 $9.50 $111.50 -$0.01 0.00% -15.9%
Activity 6 $100.00 $2.00 $9.00 $111.00 $61.20 $38.80 -$11.00 $100.00 $2.00 $9.00 $61.20 $38.80 $11.50 $9.50 $111.50 $0.50 5.67% -11.1%
Activity 7 $100.00 $2.00 $8.50 $110.50 $61.20 $38.80 -$10.50 $100.00 $2.00 $8.50 $61.20 $38.80 $11.50 $9.50 $111.50 $1.00 11.88% -5.9%
Activity 8 $100.00 $2.00 $8.00 $110.00 $61.20 $38.80 -$10.00 $100.00 $2.00 $8.00 $61.20 $38.80 $11.50 $9.50 $111.50 $1.50 18.88% 0.0%
Activity 9 $100.00 $2.00 $7.50 $109.50 $61.20 $38.80 -$9.50 $100.00 $2.00 $7.50 $61.20 $38.80 $11.50 $9.50 $111.50 $2.00 26.8% 6.7%
Activity
UNASSISTED VALUE OF OUTPUTS, INPUTS AND VALUE ADDED ASSISTED VALUE OF OUTPUTS, INPUTS AND VALUE ADDED
EFFECTIVE RATE OF ASSISTANCE
PROVIDED TO DISPENSING ACTIVITY
(ERA)
59
Table 16: Current effective rates of assistance provided to different types of pharmacies
Source: Data outlined in Appendix 2 and Appendix 3
Notes:
1. Excludes community pharmacies that prepare chemotherapy drugs 2. The effective rate of assistance represents the government assistance related to dispensing activities only. 3. Pharmacy remuneration for dispensing from both under co-payment and over co-payment prescriptions have been included in assisted value added (AVA) and excluded in
unassisted value added (UVA) for the calculation of the effective rate of assistance. This assumption is based on the regulated nature of dispensing remuneration. 4. AVA and UVA is calculated on a per script basis. AVA equals revenue per dispense times the number of scripts. UVA equals cost per dispense times the number of scripts. 5. Pharmacy cost per script has been increased by 10% to compensate for a return on investment for the purposes of the UVA and effective rate of assistance calculations. This
was done instead of using the user cost of capital above because it is not measured on a per script basis. 6. Government assistance towards the cost of the medicine included in both AVA and UVA. 7. User cost of capital equals return on investment and return of capital. 8. The cost per script is a proxy for the actual average cost per script for pharmacies and includes potential inefficiencies as well as efficiencies. These costs per script are not
reflective necessarily of the efficient cost per script.
CURRENT STATE
Pharmacy Financial Summary Micro Small Medium Large Micro Small Medium Large Micro Small Medium LargeAverage Script Volume 22,891 78,229 160,706 127,493 22,891 78,229 160,706 127,493 22,891 78,229 160,706 127,493
REVENUE PBS PBS SCR PT REVENUE 790,927 2,844,232 10,003,291 21,408,276 790,927 2,844,232 10,003,291 21,408,276 790,927 2,844,232 10,003,291 21,408,276
Average remuneration per script 11.25 11.28 11.63 13.63 11.25 11.28 11 63 13.63 11.25 11 28 11 63 13 63
NON-PBS NON-PBS REVENUE 197,732 711,058 2,500,823 5,352,069 197,732 711,058 2,500,823 5,352,069 197,732 711,058 2,500,823 5,352,069
Sales mix (PBS %) 80% 80% 80% 80% 80% 80% 80% 80% 80% 80% 80% 80%
TOTAL REVENUE 988,659 3,555,290 12,504,114 26,760,344 988,659 3,555,290 12,504,114 26,760,344 988,659 3,555,290 12,504,114 26,760,344
GROSS PROFIT Absolute Value 346,567 1,202,625 2,500,823 3,746,448 346,567 1,202,625 Not Available Not Available 346,567 1,202,625 2,500,823 3,746,448
Percentage % 39% 38% 20% 14% 39% 38% Not Available Not Available 39% 38% 20% 14%
EXPENSES PBS ATTR BUTABLE TO PBS (aos) 177,777 665,263 1,215,271 759,772 213,145 869,781 Not Available Not Available 347,012 1,024,698 1,915,498 2,384,272
PBS cost allocation per script 7.77 8.50 7.56 5.96 9.31 11.12 Not Available Not Available 15.16 13.10 11 92 18.70
NON-PBS ATTR BUTABLE TO NON-PBS (aos 61,410 241,170 410,855 878,816 73,627 315,312 Not available Not available 119,869 371,472 647,585 2,757,851
TOTAL EXPENSES aos 255,424 967,964 1,736,512 1,749,819 306,239 1,265,540 Not Available Not Available 498,575 1,490,945 2,737,070 5,491,182
NET PROFIT (aos) Absolute Value 91,143 234,661 764,311 1,996,629 40,329 (62,915) Not Available Not Available (152,007) (288,320) (236,248) (1,744,734)
Percentage % 9 22% 6 60% 6.11% 7.46% 4.08% -1.77% Not Available Not Available -15.38% -8.11% -1.89% -6.52%
NET PROFIT (bos) Percentage % 17.79% 9 23% 7.11% 8.26% 12.65% 0.86% Not Available Not Available -6.80% -5.48% -0.89% -5.72%
NET ASSETS NET ASSETS 835,949 2,923,634 9,878,250 15,788,603 835,949 2,923,634 Not available Not available 835,949 2,923,634 9,878,250 15,788,603
13% 10% 9% 13% 7% 1% Not Available Not Available -14% -7% -1% -9%
ASSISTED VALUE ADDED 257,588 882,649 1,868,968 1,737,133 257,588 882,649 Not Available Not Available 257,588 882,649 1,868,968 1,737,133
UNASSISTED VALUE ADDED 195,555 731,789 1,336,799 835,749 234,459 956,760 Not Available Not Available 381,714 1,127,168 2,107,047 2,622,699
EFFECTIVE RATE OF ASSISTANCE 32% 21% 40% 108% 10% -8% Not Available Not Available -33% -22% -11% -34%
Profitable Non-TaxableProfitable Taxable Not Profitable
USER COST OF CAPITAL
60
2.2.3 Effects of proposed changes to current arrangements on equity of remuneration
What effect would paying pharmacies a flat dispensing fee per script have on the equity of pharmacy remuneration arrangements?
One of the potential options for reform identified in the Review’s Interim Report would involve
replacing the different fees that are currently paid to pharmacies for dispensing with a single fee per
script in the range from $9.00 to $11.50 per script, which would be achieved through the
implementation of Option 4.3 which states that:
Option 4.3: Benchmark for an efficient dispense. On the basis of the information that has
been made available to the Panel, and the given data limitations, the Panel considers that the
current benchmark for a best practice dispense be set within a range of $9.00 to $11.50. This
should be reflected in the average compensation paid to a pharmacy for a dispense.
For the purposes of this report, it has been assumed for illustrative purposes that the flat fee for
dispensing would be set at $10 per script. It is estimated that this would:
reduce the weighted average remuneration received by pharmacists for each script they fill from:
$11.25 per script to $10.00 per script for micro pharmacies;
$11.28 per script to $10.00 per script for small pharmacies;
$11.69 per script to $10.00 per script for medium pharmacies;
$13.03 per script to $10.00 per script for large pharmacies; and
$18.08 per script to $10.00 per script for very large pharmacies;
potentially improve the equity of current pharmacy remuneration arrangements by reducing
unintended differences in the effective rates of assistance afforded different types of pharmacies.
As indicated in Table 15, Table 18 and Table 19. It is estimated that the introduction of a flat
dispensing fee of $10 per script would result in lower and more uniform effective rates of
assistance across the different types of pharmacies;
reduce the effective rates of assistance afforded micro pharmacies by 46 per cent; and
significantly reduce the effective rates of assistance that are afforded higher value adding
pharmacies.
The implications of these reductions in effective rates of assistance for the remuneration received by
different types of pharmacies is discussed further below.
Consider first the implications of reducing the effective rates of assistance afforded micro pharmacies.
If, as data suggests, the smallest pharmacies are the least profitable (in dollar terms),
then it follows that the immediate effect of any reduction in the amount of remuneration provided to
pharmacies would be to further reduce the profitability of those pharmacies and potentially force their
closure.
This raises a key question regarding the geographic distribution of the smallest and least efficient
pharmacies across Australia. Are these micro pharmacies uniformly spread across regional areas of
Australia, or is there a greater proportion of those pharmacies located in either metropolitan or more
rural and remote areas? As indicated in Table 17:
61
Australia’s major cities and inner regional areas have the largest numbers of micro pharmacies
(1,808 and 410 micro pharmacies respectively), but those micro pharmacies comprise the
smallest proportion of existing pharmacies in those regions (55% and 45% respectively). This
means that although there are a large number of micro pharmacies in major cities that would
potentially be adversely affected by any reduction in the amount of remuneration provided by the
government, the residents of those regions of Australia would still have access to a large number
of other pharmacies in those regions; and
Australia’s most remote regions have the highest proportions of micro pharmacies. For example,
98 per cent of pharmacies in very remote regions, as well as 84 per cent of pharmacies in remote
regions, are micro pharmacies. This means that although there are only a small number of micro
pharmacies that are likely to be adversely affected by a reduction in the amount of remuneration
provided by the government, the closure of those pharmacies would have a disproportionally
greater adverse impact on the access that the residents of those regions to affordable medicines
due to the small numbers of other potentially more profitable pharmacies in those regions. This
highlights both the:
significant risk that a reduction in pharmacy remuneration could compromise the continuity of
supplies of affordable medicines to the populations in the more remote regions of Australia;
and
consequent need to:
− monitor the financial viability of micro pharmacies, particularly those located in the
more remote regions of Australia, in order to identify any potential threats to the
continuity of supply of affordable medicines to their catchment populations (e.g. by
requiring pharmacies to supply the government with copies of their income tax
returns, as is the approach that is adopted for suppliers of other essential services,
such as public bus transport services in NSW and Queensland); and/or
− consider the need to either increase funding to more remote pharmacies (e.g. through
increases in the RPMA, provide transitional assistance pending the entry of more
efficient pharmacies in those regions, or increase the use of online pharmacy services
to those regions).
Table 17: Geographic distribution of micro pharmacies
Source: PBS data
Notes:
* Revenue based on the financial year 2015-16.
** Only pharmacies that traded the full financial year and have PhARIA assigned as at March 2015 are
included.
Number of micro
pharmacies
(PBS revenue* <
1.6 million)
Total number of
pharmacy**
Percentage of
total pharmacies
Major Cities of Australia 1,808 3,270 55%
Inner Regional Australia 410 911 45%
Outer Regional Australia 278 490 57%
Remote Australia 62 74 84%
Very Remote Australia 40 41 98%
Total 2,598 4,786 54%
62
Now consider the effects of reducing the effective rates of assistance that are provided to those
pharmacies that are adding greater value to their inputs. It appears from the data that some of the
largest pharmacies are involved in the performance of relatively high value adding activities (e.g.
supply of high cost medicine). This raises the issue as to whether additional assistance should be
provided to the performance of those activities if a flat dispensing fee was to be introduced (e.g. one
set at $10 per script).
Just as it may be necessary to consider increasing the amount of remuneration provided to more
remote pharmacies if a flat dispensing fee was to be introduced, it may also be necessary to consider
the extent to which it is necessary to increase the amount of remuneration that is provided to
pharmacists for the performance of higher value adding activities such as the dispensing of high cost
medicines that require the pharmacist to perform more complex services that add greater economic
value to the costs of their inputs.
What effect would the removal of the pharmacy location rules have on the equity of current pharmacy remuneration arrangements?
As noted in section 2.1.3, another potential option for reform identified in the Review’s Interim Report
is the removal of current restrictions on the location of new pharmacies and the relocation of existing
pharmacies (Option 5.1).
In addition to potentially improving the equity of access of Australians to the medicines they need,
such a reform also has the potential to improve the equity of current pharmacy remuneration
arrangements by reducing the extent to which those rules:
prevent pharmacies from locating in those areas where there is the highest demand for the
particular types of medicines and services they supply. As indicated in Table 11, current location
rules are still resulting in the rejection of per cent of new pharmacy applications
as well as per cent of applications to relocate pharmacies
; and
provide less efficient pharmacies with higher levels of assistance (higher effective rates of
assistance) than more efficient pharmacies (e.g. by preventing new, more efficient, pharmacies
from locating nearby existing pharmacies supplying similar medicines).
As discussed further in section 3.2.3, the removal of existing restrictions on pharmacy location may
also increase the welfare of the nation as a whole by reducing the extent to which those location rules
distort the level, pattern and location of pharmacy production, investment and resource use.
63
Table 18: Effective rates of assistance provided to different types of pharmacies following the introduction of a $10 flat fee for dispensing
Source: Data outlined in Appendix 2 and Appendix 3.
Notes: 1. Excludes community pharmacies that prepare chemotherapy drugs 2. The effective rate of assistance represents the government assistance related to dispensing activities only. 3. Pharmacy remuneration for dispensing from both under co-payment and over co-payment prescriptions have been included in assisted value added (AVA) and excluded in
unassisted value added (UVA) for the calculation of the effective rate of assistance. This assumption is based on the regulated nature of dispensing remuneration. 4. AVA and UVA calculated on a per script basis. AVA equals revenue per dispense times the number of scripts. UVA equals cost per dispense times the number of scripts. 5. Pharmacy cost per script has been increased by 10% to compensate for a return on investment for the purposes of the UVA and effective rate of assistance calculations. This
was done instead of using the user cost of capital above because it is not measured on a per script basis. 6. Government assistance towards the cost of the medicine included in both AVA and UVA. 7. User cost of capital equals return on investment and return of capital.
8. The cost per script is a proxy for the actual cost per script for pharmacies and includes potential inefficiencies as well as efficiencies. These costs per script are not reflective necessarily of the efficient cost per script.
PROPOSED CHANGES
Pharmacy Financial Summary Micro Small Medium Large Micro Small Medium Large Micro Small Medium Large22,891 78,229 160,706 127,493 22,891 78,229 160,706 127,493 22,891 78,229 160,706 127,493
REVENUE PBS PBS SCR PT REVENUE 762,252 2,743,871 9,741,380 20,946,068 762,252 2,743,871 9,741,380 20,946,068 762,252 2,743,871 9,741,380 20,946,068
Proposed remuneration per script 10.00 10 00 10.00 10 00 10 00 10.00 10 00 10.00 10.00 10.00 10.00 10.00
NON-PBS NON-PBS REVENUE 197,732 711,058 2,500,823 5,352,069 197,732 711,058 2,500,823 5,352,069 197,732 711,058 2,500,823 5,352,069
Sales mix (PBS %) 80% 80% 80% 80% 80% 80% 80% 80% 80% 80% 80% 80%
TOTAL REVENUE 959,984 3,454,929 12,242,203 26,298,137 959,984 3,454,929 12,242,203 26,298,137 959,984 3,454,929 12,242,203 26,298,137
GROSS PROFIT Absolute Value 317,892 1,102,263 2,238,912 3,284,240 317,892 1,102,263 Not Available Not Available 317,892 1,102,263 2,238,912 3,284,240
Percentage % 39% 38% 20% 14% 39% 38% Not Available Not Available 39% 38% 20% 14%
EXPENSES PBS ATTR BUTABLE TO PBS (aos) 177,777 665,263 1,215,271 759,772 213,145 869,781 Not Available Not Available 347,012 1,024,698 1,915,498 2,384,272
PBS cost allocation per script 7.77 8 50 7.56 5 96 9 31 11.12 Not Available Not Available 15.16 13.10 11.92 18.70
NON-PBS ATTR BUTABLE TO NON-PBS (aos 61,410 241,170 410,855 878,816 73,627 315,312 Not available Not available 119,869 371,472 647,585 2,757,851
TOTAL EXPENSES aos 255,424 967,964 1,736,512 1,749,819 306,239 1,265,540 Not Available Not Available 498,575 1,490,945 2,737,070 5,491,182
NET PROFIT (aos) Absolute Value 62,468 134,300 502,401 1,534,421 11,653 (163,276) Not Available Not Available (180,683) (388,682) (498,158) (2,206,942)
Percentage % 6.51% 3.89% 4.10% 5.83% 1 21% -4.73% Not Available Not Available -18.82% -11.25% -4.07% -8.39%
NET PROFIT (bos) Percentage % 15.33% 6.59% 5.13% 6.65% 10 04% -2.02% Not Available Not Available -9.99% -8.55% -3.05% -7.58%
NET ASSETS NET ASSETS 811,703 2,841,104 9,671,340 15,515,901 811,703 2,841,104 Not available Not available 811,703 2,841,104 9,671,340 15,515,901
10% 7% 6% 11% 4% -3% Not Available Not Available -18% -10% -3% -12%
ASSISTED VALUE ADDED 228,912.66 782,287 24 1,607,057.78 1,274,925 00 228,912 66 782,287.24 Not Available Not Available 228,912.66 782,287.24 1,607,057.78 1,274,925.00
UNASSISTED VALUE ADDED 177,777.46 665,263.10 1,215,271.49 759,771 63 213,144 81 869,781.37 Not Available Not Available 347,012.50 1,024,698.10 1,915,497.61 2,384,271.86
EFFECTIVE RATE OF ASSISTANCE 17% 7% 20% 53% -2% -18% Not Available Not Available -40% -31% -24% -51%
Profitable Taxable Profitable Non-Taxable Not Profitable
Average Script Volume
USER COST OF CAPITAL (ROI & ROC) aos
64
Table 19: Effect of introducing an illustrative $10 flat fee for dispensing on the effective rates of assistance afforded different types of pharmacies
Source: Data outlined in Appendix 2 and Appendix 3.
Current $10 flat fee % Change Current $10 flat fee % Change Current $10 flat fee % Change Current $10 flat fee % Change
Micro 11.25 10 -11% 18% 15% -14% 23% 20% -12% 32% 17% -46.2%
Small 11.28 10 -11% 9% 7% -29% 13% 10% -24% 21% 7% -66.5%
Medium 11.63 10 -14% 7% 5% -28% 10% 8% -25% 40% 20% -49.2%
Large 13.63 10 -27% 8% 7% -20% 15% 12% -18% 108% 53% -51.3%
Very large
Micro 11.25 10 -11% 13% 10% -21% 17% 14% -17% 10% -2% -124.0%
Small 11.28 10 -11% 1% -2% -336% 4% 0% -90% -8% -18% -135.4%
Medium
Large
Very large
Micro 11.25 10 -11% -7% -10% -47% -4% -8% -86% -33% -40% -23.1%
Small 11.28 10 -11% -5% -9% -56% -3% -7% -106% -22% -31% -41.0%
Medium 11.63 10 -14% -1% -3% -243% 1% -2% -424% -11% -24% -110.0%
Large 13.63 10 -27% -6% -8% -32% -7% -11% -42% -34% -51% -52.2%
Very large Not AvailableNo
t P
rofi
tab
le
Category
Fee Structure
Not Available
Not Available
Not Available
Not Available
Net Profit User Cost of Capital Effective Rates of Assistance
Pro
fita
ble
Tax
able
Pro
fita
ble
No
n-T
axab
le
65
ECONOMIC EFFICIENCY
In addition to improving distributional equity, the current pharmacy remuneration and regulation are
also intended to improve the welfare of Australians by increasing the economic efficiency with which
the nation’s scarce resources are used.
In particular, the current pharmacy remuneration and regulation are intended to:
improve the efficiency with which medicines are used (“consumption efficiency”); and
improve the efficiency with which medicines, as well as other goods and services, are supplied
(“production efficiency”).
However, in the course of seeking to improve the access of Australians to affordable medicines and
the efficient use of those medicines, the PBS in conjunction with the current pharmacy remuneration
and regulation also have the potential to impose real economic costs on the nation as a whole by:
reducing consumption efficiency by altering the relative prices that Australians pay for alternative
medicines; and
reducing production efficiency by distorting the relative rates of return that pharmacies earn from
supplying medicines on behalf of the government.
Further reductions in consumption and production efficiency can also arise as a result of the:
adverse effects that the inequities in the access of Australians to affordable medicines, as well as
the inequities in pharmacy remuneration, can have on economic efficiency, which are discussed
further below; and
adverse effects that attempts to improve the fiscal sustainability of current pharmacy
remuneration arrangements have on economic efficiency, which are discussed further in section
3.
This section:
seeks to identify the intended effects of the PBS and the current pharmacy remuneration and
regulation on economic efficiency;
outlines available information on the actual effects of these current regulatory and remuneration
arrangements, which include both their intended and potentially unintended effects on economic
efficiency; and
discusses the extent to which proposed changes to those current arrangements are expected to
improve their intended efficiency objectives.
3.1 Consumption efficiency
3.1.1 Intended effects on consumption efficiency
Although the National Medicines Policy notes that cost should not constitute a substantial barrier to
people’s access to the medicines they need, it also notes the importance of ensuring that the
arrangements used to promote that improved access are consistent with the “rational” use of those
medicines (the efficient and cost effective use of medicines in treating a particular health condition):
66
“However, access to medicines should support the rational use of those medicines. Users should
be encouraged to understand the costs, benefits and risks of medicines, and wherever possible
the public benefit of provision of medicines should be achieved through the regulated marketplace
in which medicines are placed.
... In the context of the ongoing development and release of new medicines which are often
relatively expensive, it can be difficult to meet the community’s expectations regarding subsidised
access to all available treatments. Both the effectiveness and cost-effectiveness of the treatments
need to be considered in making decisions about subsidisation.” 5
This is the reason why the 1996 COAG agreement on the provision of health and community
services, on which the National Medicines Policy is based, stresses the importance of “cost effective
care” and delivering “better value for taxpayers dollars”.
In particular, underlying the design of the National Medicines Policy, the PBS and the current
pharmacy remuneration and regulation is a concern that in the absence of such government
interventions, Australians would:
not purchase sufficient types and quantities of medicines as a result of:
high prices charged by manufacturers for medicines which can exceed the marginal cost of
supplying those medicines (the manufacturers of medicines often have to charge prices in
excess of the efficient marginal costs of supplying those medicines in order to earn additional
revenue to recover the high fixed costs of supplying those medicines). This is the reason why
the PBS arrangements have been designed to provide the highest levels of assistance to
those patients who have to use the highest cost medicines to meet their particular health
needs;
insufficient income to afford to purchase the types and quantities they need to meet their
health needs. This is the reason why the PBS includes arrangements which have been
designed to provide the highest levels of assistance to those patients on the lowest incomes
(e.g. those “concessional” patients who hold an Australian government concession card);
not have sufficient information on the types of medicines available and the relative efficacy of
those medicines to determine the appropriate types and quantities of medicines that they should
purchase.
In addition, it appears that the:
current patient co-payments are also intended to reduce the extent to which, in the absence of
those co-payments, patients would consume excessive quantities of those medicines (these co-
payments are intended to perform much the same function as does an “excess” payment required
under most other insurance contracts. It is intended to reduce the “moral hazard” that would
otherwise arise if patients were not required to meet part of the costs of their medicines).
However, it is important to note that the “moral hazard” is reduced in the first instance by the
gatekeeper role of prescribers;
pharmacy location rules are intended to improve the access that patients have to affordable
medicines by reducing the generalised costs that patients would otherwise have to incur in order
to visit a pharmacy;
5 Department of Health and Ageing (2000). National Medicines Policy, p2.
67
pharmacy ownership rules are intended to improve the quality of advice that Australians would
otherwise have received from pharmacists in the absence of those rules; and
pharmacy and wholesale remuneration arrangements are intended to increase the types and
quantities of medicines that would otherwise have been available to Australians at the prices they
currently pay for those medicines; and
3.1.2 Actual effects on consumption efficiency
What effect does the PBS have on the efficiency with which medicines are used?
The PBS provides a significant level of financial assistance for Australians that use PBS medicines.
This has the intended effect of significantly increasing the ability of Australians to afford the quantities
and types of medicines they need.
The gross benefit that Australians derive from the use of medicines (the gross “value in use” of those
medicines to Australians) exceeds the sum of what they and the government pay for those medicines
(their “value in exchange”) by an amount that is equal to the net benefit they derive from using those
medicines (the “patient surplus” they derive from using those medicines, which is equal to the
difference between what they would have been willing to pay to use those medicines and services
less what they actually had to pay).
In particular, as outlined in section 2.1.2, the patient co-payments have the intended effect of
providing higher levels of assistance to those Australians who have:
lower incomes (the amount of subsidy provided to individuals on lower incomes is greater as a
result of the concessional co-payment that applies to concessional patients); and
greater need for medicines to meet their health needs. In particular, a higher level of assistance is
provided to those patients who have to use:
greater quantities of medicines to meet their health needs (the amount of subsidy increases
as the quantity of medicines they need increases); and
higher priced medicines to meet their health needs (the amount of subsidy increases as the
price of those medicines increases).
In seeking to improve the equity of access to affordable medicines across patients with different
health needs and incomes, the PBS has the potential to unintentionally alter the decisions that
prescribers make regarding the types and quantities of medicines that they should prescribe to meet
the specific health needs of their patients.
The effects that the current co-payments have on the relative prices of medicines to patients are
illustrated in Table 2 in section 2.1.2. This indicates the extent to which setting the co-payments for
general patients at $38.80 per script proportionally reduces the prices of different medicines to
patients (as measured by the “nominal rate of assistance” that is provided to the patients of each type
of medicine, which is equal to the unassisted price of the medicine, less the assisted price of the
medicine, divided by the unassisted price of the medicine).
68
As illustrated in Table 2, the general co-payment potentially:
alters the relative prices of medicines priced under the general co-payment (medicines 1 and 2) in
relation to over co-payment medicines (medicines 3 to 9). (it provides higher nominal rates of
assistance to the use of medicines 3 to 9 than it does to medicines 1 and 2); and
alters the relative prices of over co-payment medicines (the relative prices of medicines 3 to 9).
Specifically, it reduces the relative prices of higher priced over co-payment medicines in relation
to lower priced over co-payment medicines (the nominal rate of assistance provided medicines 3
to 9 increases as the cost of those medicines increase).
As a result, although the co-payments have the intended effect of enabling Australians to gain access
to a wide range of affordable medicines, in so doing, it has the potential to encourage the use of more
expensive medicines listed on the PBS by providing the highest nominal rates of assistance to the
use of those medicines. This is because the co-payments and safety net thresholds in effect provide
patients with a lump sum subsidy per script (a “volume based” subsidy), rather than a subsidy based
on the value of those scripts (a “value based” or “ad valorem” subsidy). This does not suggest that a
“value based” subsidy would be more appropriate, because it would significantly alter the ability of
many Australians to afford PBS medicines, but simply highlights some of the potential impacts of a
“volume based” subsidy in the absence or failure of the measures listed below.
There are measures in place that are intended to increase consumption efficiency. Specifically,
all medicines listed on the PBS have undergone a rigorous cost effectiveness assessment;
therapeutic group policy ensures that the government only subsidises medicines up to the level of
the lowest priced medicine in a group of medicine with similar safety and efficacy 6;
the role of prescribers as gatekeepers to PBS medicines and their duty to prescribe according to
clinical need.
In addition to potentially altering the relative prices of medicines, the current pharmacy regulations
also have the potential to alter the relative prices of other goods supplied by pharmacies. By requiring
Australians to physically visit pharmacies, or an online pharmacy website, in order to purchase their
medicines, current pharmacy regulation appears to have the unintended effect of providing patients
the opportunity to purchase other goods that they may otherwise have purchased at lower prices from
other suppliers (e.g. supermarkets).
While patients are free to make this choice and derive benefit from the convenience of being able to
purchase a range of other goods from the pharmacies they visit, this comes at the cost of them
potentially paying higher prices for those goods than they would have if they had not been required to
visit the pharmacy to fill their prescription. In this regard, it is important to note that different
pharmacies often charge very different prices for the non-PBS goods they sell.
In general, the magnitude of the potential economic costs that the nation bears as a result of any
remaining alteration in relative prices of medicines will be greater the:
greater the alteration in the relative prices of medicines (the greater the difference in the nominal
rates of assistance afforded medicines);
more sensitive decisions regarding the use of medicines are to the relative prices of those
medicines, which depends on both the:
6 The Pharmaceutical Benefits Scheme, https://www.pbs.gov.au/browse/therapeutic-group, accessed 4 May 2017.
69
degree of interchangeability in consumption between medicines whose relative prices have
been altered; and
extent to which medical practitioners actually take into account the relative prices of
medicines when making their decisions regarding the types of medicines to prescribe their
patients.;
greater the quantity of that medicine consumed. Even if the current measures to improve
consumption efficiency, as outlined above, only result in a relatively small alteration in the relative
prices of medicines, they can still impose a significant economic cost on the nation as a whole if
those medicines are consumed in large quantities.
What effect does the ability of pharmacies to discount the prices they charge for medicines have on consumption efficiency?
As noted in section 2.1.2, the current pharmacy remuneration and regulation enable pharmacists to:
reduce the patient co-payment by up to $1 for over co-payment scripts; and
charge patients prices that are above or below the dispensed price per script for under co-
payment scripts.
The ability of businesses to vary the prices that they charge for the goods and services they supply is
an important requirement to ensure the efficient operation of the market for those goods and services.
In competitive markets, it ensures that the prevailing market prices for those goods and services
reflect both the:
marginal benefits that patients derive from their use of those goods and services; and
marginal costs of supplying those goods and services (the efficient costs of supplying those
services).
By contrast, however, in less competitive markets, there is a risk that suppliers could choose to
charge prices that differ from efficient market prices. For example, suppliers could choose to use their
market power to charge higher prices for certain goods and services in order to cross subsidise the
cost of supplying other goods and services for which they are under-remunerated.
As indicated in:
Table 5 in section 2.1.2, the ability of pharmacies to vary the prices they charge for under co-
payment scripts alters the relative prices that general patients have to pay for the top 10
medicines. In particular, Table 5 suggests that such price variations can generate significant
differences in both the:
relative prices that patients pay for the same medicine (e.g. bio-equivalent medicines); and
relative prices that patients pay for different, but potentially interchangeable, medicines (e.g.
medicines within the same therapeutic group);
Table 7 in section 2.1.3, although the ability of pharmacies to vary the prices they charge for
under co-payment scripts has reduced the prices that general patients paid for the medicines in
the urban regions of Australia (PhARIA 1), it has increased the prices that patients paid for the
medicines in the more remote regions of Australia (PhARIA 3 to 6).
If the dispensed price is considered to be a reasonable proxy for the efficient cost of dispensing each
medicine, then allowing pharmacies to charge different prices for those medicines not only has the
70
potential to reduce the equity of access of Australians to affordable medicines in the more remote
regions of Australia, but also has the potential to affect the consumption patterns of PBS medicine by
further altering its relevant prices.
3.1.3 Effects of proposed changes to pharmacy remuneration and regulation arrangements on consumption efficiency
What effect would the removal of the ability of pharmacies to charge patients different prices for medicines have on consumption efficiency?
As noted in section 2.1.3, one of the potential options for reform identified in the preliminary report
would involve removing the ability that pharmacies currently have to charge patients different prices
for their medicines they supply through the implementation of:
Option 2.1, which would remove the ability of pharmacies to charge prices that are either below or
above the dispensed price; and
Option 2.2, which would remove the ability of pharmacies to discount the amount that patients
have to pay for over co-payment scripts by up to $1 per script.
At first sight, it might seem that such a proposed reform is more likely to reduce, rather than improve,
the economic efficiency with which those different types of medicines are used by Australians
(reduce, rather than increase, consumption efficiency).
In theory, this would be the case if the prevailing market prices that patients currently pay for their
medicines accurately reflected both the:
marginal benefits that patients derive from the use of those medicines (their willingness to pay for
those medicines); and
efficient marginal costs of supplying those services.
In practice, however, this is not the case since the:
patient co-payments have the effect of altering the relative prices that patients are charged for
their medicines; and
fees that pharmacists are paid for supplying different types of medicines on behalf of the
government do not reflect the efficient costs of supplying those medicines. Rather, they are more
the result of historical precedent, as amended multiple rounds of negotiation between the
government and the Pharmacy Guild; and
existence of information asymmetries affect the transparency of the prices of PBS medicines at
multiple levels in the pharmaceutical supply chain, including at the pharmacy level.
As a result:
it is inevitable that the market prices that patients currently pay for their medicines will differ from
the efficient market prices of those medicines. Even if some of the current market prices that
pharmacies charge for their medicines might accurately reflect the efficient market prices of those
medicines, it is reasonable to assume that there will be many medicines whose prices to patients
differ significantly from the efficient market prices of those medicines; and
the economic costs that patients and the nation as a whole incur when the current market prices
of medicines differ from their efficient market prices will significantly exceed the economic benefits
71
that arise when the prevailing market price accurately reflect the efficient market price of those
medicines.
This means that rather than reducing consumption efficiency, the implementation a uniform price for
each type of medicine and patient category has the potential to improve consumption efficiency by:
reducing unintended differences in the relative prices that patients are charged:
reducing the extent to which these differences in relative prices affect consumption patterns.
3.2 Production efficiency
3.2.1 Intended effects on production efficiency
In addition to improving the efficiency with which Australians use medicines (“consumption
efficiency”), the current pharmacy remuneration and regulation are also intended to improve the
efficiency with which those medicines are supplied (“production efficiency”) and deliver “value for
money”, which is an important objective identified by the National Medicines Policy.
In particular, these current arrangements are intended to address the concern that, in the absence of
such government interventions, the operation of the market would fail to supply Australians with
sufficient quantities of the types of medicines they need to meet their health needs in view of the
existence of:
inadequate and incomplete information regarding the efficacy and appropriate use of medicines.
In the absence of government intervention, there is a risk that there would be an undersupply of
information regarding the efficacy of medicines and their appropriate use in view of the “public
good” features of that information, namely:
the benefits that any Australian or their agent (e.g. medical practitioner) derives from their use
of information on the efficacy and appropriate use of pharmaceuticals does not reduce the
quantity of such information that is available for use by other Australians (such information
exhibits “non – rivalry”, or “jointness” in consumption); and
it is difficult, and undesirable, to prevent those individuals who have not paid for the supply of
information on pharmaceuticals from enjoying the benefits arising from the use of that
information (the benefits arising from the use of such information are “non-excludable”). Not
all of the benefits arising from the use of certain medicines are enjoyed by the patients of
those medicines. Rather, some of those benefits “spill over” onto other sections of the
community (e.g. the community derives external benefits from the appropriate use of
medicines that reduce the risk of communicable diseases);
economies of scale in the production of pharmaceuticals. The supply of pharmaceuticals is
characterised by significant economies of scale in view of the high fixed costs (e.g. the high costs
of research and development) and the relatively low marginal costs associated with supplying
additional quantities of pharmaceuticals. This means that in order to recover their fixed costs,
pharmaceutical manufacturers need to charge prices that exceed the efficient marginal costs of
supplying those pharmaceuticals; and
imperfect competition. The existence of significant economies of scale in the production of
pharmaceuticals means that the industry is dominated by a small number of large companies that
supply most of the world’s pharmaceuticals. This not only reduces the level of competition
between those manufacturers, but it also alters the nature of that competition (e.g. it increases the
use of non-price competition).
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Specifically, the current:
pharmacy ownership rules are intended to improve the quantity and quality of information
supplied to Australians regarding the types of medicines available to meet their particular health
needs, their relative efficacy, appropriate use and potential side effects;
pharmacy location rules are intended to reduce the economic costs that the nation would
otherwise incur in the absence of those regulations (they are intended to reduce the economic
costs that the nation would otherwise incur as a result of unrestricted competition between
pharmacies for the economic rents arising from the regulations imposed on pharmacy ownership
– that is, from unrestricted “rent seeking” activity); and
incentives provided to pharmacies to encourage them to substitute cheaper generic medicines,
where available, are intended to improve the extent to which the medicines used by Australians
are the most cost effective ones (these incentives are intended to improve the extent to which the
level and pattern of demand for medicines reflects the level and pattern of supply of those
medicines – that is, the incentives are intended to improve “efficiency in exchange”). By setting
the co-payment that Australians are required to pay for their medicines, the PBS has the effect of
reducing the incentive that pharmacists would otherwise have had to provide cheaper medicines
to their customers where they are available. The current incentive provided to pharmacists to
encourage them to substitute cheaper generics is intended to reduce that adverse effect to some
extent. Similarly, the government’s practice of listing only cost effective pharmaceuticals on the
PBS is also intended to improve efficiency in exchange to some extent by increasing the supply of
the cheaper PBS medicines where they are available.
3.2.2 Actual effects on production efficiency
The current pharmacy remuneration and regulation provide significant levels of assistance to
pharmacies which encourages the provision of much higher quantities and types of medicines to
Australians than would have occurred in the absence of such assistance.
The gross benefit that pharmacies derive from supplying medicines on behalf of the government is
equal to the gross revenue that they receive from government and patients for those medicines and
services (the “value in exchange” of those medicines and services). This gross benefit exceeds the
costs that they actually incur in order to supply each unit of those goods and services by an amount
that is equal to the net benefit that pharmacists derive from supplying medicines on behalf of the
government (the “produce surplus” they derive from the supply of those medicines and services,
which is equal to the market value of those goods and services less the cost of supplying those
medicines – that is, the amount of revenue that they would have been willing to receive in return for
supplying those goods and services).
However, in the course of increasing the quantities and types of medicines supplied to Australians
and the ease of access that Australians have to community pharmacies, the current pharmacy
remuneration and regulation also have the potential to impose a net economic cost on the nation as a
whole by unintentionally encouraging less efficient levels and patterns of production, investment, and
resource use (“production inefficiencies”).
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In particular, the current regulatory constraints that are imposed on the location and ownership of
pharmacies have the potential to adversely affect production efficiency by reducing the level of
competition and altering the nature of competition between pharmacies and other businesses.
Specifically, the current:
pharmacy location rules have the potential to:
encourage the emergence of large numbers of very small pharmacies. Even the largest and
most profitable pharmacies in Australia are relatively small in relation to other major retailers
of goods and services. As indicated in Table 14 , data indicates that:
− per cent of pharmacies are micro pharmacies with an annual turnover of less than
$2m; and
− per cent of pharmacies are micro and small pharmacies with an annual turnover of
less than $10m per annum;
Although this proliferation of very small pharmacies provides the residents of Australia’s major
cities with much better physical access to community pharmacies than other goods and
services (e.g. suburban shopping centres and banks), this comes at an increased cost to both
the government and the nation as a whole by reducing the efficiency with which those
medicines are supplied. There are real economic reasons why suburban shopping centres are
being increasingly replaced by a fewer number of much larger, strategically located, and more
efficient shopping centres, complemented by online shopping facilities for those individuals
who have greater difficulty visiting those facilities in person. It is simply not economic to
attempt to locate pharmacies in close proximity to Australia’s geographically dispersed
population unless patients, or the government, are willing to pay higher prices to cover the
additional economic cost of that convenience; and
provide a competitive advantage to existing pharmacies in the markets for their outputs,
inputs and factors of production (land, labour and capital). Since the government has
restricted the supply of prescription medicines and pharmacy only medicines to pharmacies
for public safety reasons, Australians have to either visit a pharmacy in person, or the website
operated by a pharmacy, in order to obtain their supplies of those restricted medicines. This
places pharmacies at a competitive advantage in the markets for their outputs, inputs and
factors of production in relation to other Australian businesses. In particular, by locating the
dispensing desk at the rear of their premises, pharmacies may be able to use the market
power they have in the supply of highly subsidised prescription medicines and pharmacy only
medicines to gain an competitive advantage over more efficient suppliers of the other non-
PBS goods and services they sell (it enables them to increase their supplies of other goods
and services that would be more efficiently supplied by other businesses). These marketing
techniques are not unique to community pharmacies. They are also employed by:
− supermarkets, which locate their supplies of highly subsidised perishable goods (e.g.
milk) at the rear of their stores in order to divert high volumes of repeat customers
past their displays of other goods, and use “shopper dockets”(“inter-temporal
bundling” techniques) to extend their significant oligopoly market power into the
provision of a range of other goods and services not typically found at supermarkets
(e.g. petrol and insurance); and
− airports and other transport hubs (e.g. railway stations and bus interchanges) use
their market power in the provision of transportation services to generate additional
profits by directing the flow of their passengers past the businesses that lease retail
space from them;
pharmacy ownership rules have the potential to reduce the extent of competition that pharmacies
face in the markets for their outputs, inputs and factors of production from much larger, and more
efficient, retailers. Although pharmacists might be experts in the provision of advice on the
74
efficacy of different types of pharmaceuticals in meeting the health needs of Australians, this does
not necessarily mean that they are experts in the marketing and distribution of the medicines they
supply on behalf of the government. It is noted that medical practices and law firms do not have to
be owned and controlled by medical practitioners and lawyers respectively, even though the
quality of advice they provide to their clients can have a significant impact on the welfare of their
clients and the nation as a whole. There is little evidence that this absence of ownership
restrictions for private hospitals, medical practices and law firms compromises the quality of the
services they provide and the welfare of their clients and the nation as a whole. As a result,
although pharmacy ownership rules might succeed in ensuring that Australians are provided with
high quality advice on the types of medicines that best meet their health needs, in so doing, those
regulations have the potential to impose an economic cost on the patients of pharmaceuticals, the
government, as well as the nation as a whole by potentially:
protecting pharmacies, particularly the larger and more profitable pharmacies, from increased
competition in the markets for their outputs, inputs and factors of production, from much larger
retailers; and.
reducing the incentive pharmacies have to increase their efficiency and reduce the economic
costs that their customers, the government and the nation as a whole incur in order to supply
Australians with the appropriate types and quantities of medicines they need to meet their
health needs.
In addition, the current pharmacy remuneration arrangements also have the potential to distort
production, investment and resource use decisions thereby imposing additional economic costs on
the nation as a whole. In particular, by paying pharmacies the same fee for performing a range of
value adding activities, the current pharmacy remuneration arrangements provide the highest
effective rates of assistance to those activities that add the least value to the inputs used. This may
have the unintended effect of distorting the relative rates of return that pharmacies derive from the
various activities they perform, thereby distorting their levels and patterns of production, investment
and resource use, and imposing a real economic cost on the nation as a whole by reducing the
efficiency with which the nation’s resources are used.
These intended and unintended effects of current pharmacy remuneration arrangements are
illustrated in Table 15 in section 2.2.2, which illustrates how paying pharmacies a single fee ($11.51)
per script to perform a range of different value adding services on behalf of the government has the
unintended effect of distorting the effective rates of assistance afforded those activities.
Specifically, it has the potential unintended effect of providing the highest effective rates of assistance
to those activities that add the least value to the inputs used by those activities. Low value adding
activities (e.g. activity 9 in Table 15) are provided with higher effective rates of assistance than higher
value adding activities (e.g. activity 1 in Table 15). This is because the current remuneration
arrangements do not pay pharmacies different fees for all of the different value adding activities they
perform.
As a result, although the current pharmacy remuneration arrangements have the intended effect of
enabling pharmacies to supply Australians with greater quantities and a wider range of medicines at
more affordable prices, in so doing, they also have the potential effect of reducing production
efficiency by providing the highest effective rates of assistance to those pharmacies that add the least
value to their inputs and are less efficient in producing their outputs.
For example, consider first the case where the value adding activities are all different and the
differences in the amount of value added are due solely to differences in the types and values of the
inputs used and outputs produced by those activities. In this case, paying pharmacies the same fee
for performing these activities may have the unintended effect of providing the lowest value adding
75
activities with the highest effective rates of assistance and encouraging pharmacies to increase the
quantities of those medicines they supply as well as their investment in those activities.
Now consider the case where the type of value adding activities performed by each of the pharmacies
are identical and the differences in the amount of value added by each activity are due solely to
differences in the efficiency with which each pharmacy performs those activities. In this case, the
effect of paying these pharmacies the same fee for performing the same activity may have the
unintended effect of providing the highest effective rates of assistance to those pharmacies that are
the least efficient in performing those activities.
Finally, consider the more realistic case where the difference in value added by each of the activities
is due to a combination of both differences in the types of activities performed by pharmacies and
differences in the efficiency with which they perform those activities. In this case, the payment of a flat
fee for the performance of those activities may unintentionally afford the highest effective rates of
assistance to those pharmacies that:
perform those activities that add the least value to the inputs they use; and
are the least efficient in performing those activities.
3.2.3 Effects of proposed changes to pharmacy remuneration and regulation on production efficiency
What effect would paying pharmacies a flat dispensing fee per script have on production efficiency?
As noted in section 2.2.3, one of the potential options for the reform of current pharmacy
remuneration arrangements identified in the Review’s Interim Report would involve replacing the
different fees that are currently paid to pharmacies for the supply of a range of different medicines
with a flat dispensing fee in the range from $9.00 to $11.50 per script (Option 4.3).
At first sight, it might seem that such a reform is more likely to reduce, rather than improve, the
economic efficiency with which those different types of medicines are supplied (reduce, rather than
increase, production efficiency). This would be the case if the current fees charged for the provision of
different types of medicines accurately reflected the actual efficient long run marginal costs of
supplying those medicines.
As outlined previously, however, considerable uncertainty currently surrounds the actual efficient long
run marginal cost associated with supplying the different types of medicines that are currently
supplied by pharmacies on behalf of the government. The current fees that are paid by the
government to pharmacies are more a reflection of historical precedent, as amended by numerous
rounds of negotiation between the government and the Pharmacy Guild. They are not the result of a
rigorous process of analysis designed to accurately estimate the efficient marginal costs of supplying
those medicines. As a result:
it is highly unlikely that the fees that the government currently pays pharmacies for these different
types of medicines will accurately reflect the efficient long run marginal costs of supplying those
medicines. Although it is possible that some of the fees paid to some pharmacies might
accurately reflect the efficient marginal costs of supplying medicines, it is more likely that most of
those fees will differ from the efficient marginal costs of supplying those medicines on behalf of
the government; and
the economic costs arising from these differences between the fees that pharmacists are paid to
supply medicines on behalf of the government and the actual efficient marginal costs of
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performing those activities will be many times higher than the economic benefits that the nation
would derive if those differences did not exist.
This means that rather than reducing production efficiency, the implementation of a flat fee for
dispensing has the potential to improve production efficiency by:
reducing unintended differences in the effective rates of assistance provided to different types of
pharmacies. Specifically, as indicated in Table 19, the introduction of an illustrative flat dispensing
fee of $10 per script has the potential to:
reduce the effective rates of assistance currently provided to each type of pharmacy (e.g. it
would reduce the effective rate of assistance provided to micro, profitable, pharmacies from
32% to 17%, a reduction of around 46%);
reduce the differences in the effective marginal rates of assistance afforded the different types
of pharmacies (e.g. prior to the introduction of the $10 flat fee for dispensing, the effective
marginal rates of assistance afforded profitable, taxable, pharmacies range from 32% to
108% for profitable, taxable pharmacies. By contrast, after the introduction of the $10 flat
dispensing fee, the effective rates of assistance would range from 7% to 53% for profitable
and taxable pharmacies); and
reduce the extent to which the current pharmacy remuneration and regulation arrangements may
encourage inefficient levels and patterns of production, investment and resource use, by
Australian pharmacies (e.g. by reducing the extent to which the current remuneration and
regulation may encourage pharmacies to engage in lower value adding and less efficient
activities, including the supply of goods and services that would be more efficiently supplied by
other Australian businesses).
What effect would removing current pharmacy location rules have on production efficiency?
As noted in section 2.2.3, another potential option for reform identified in the Review’s Interim Report
is the removal of the current pharmacy location rules (Option 5.1).
In addition to potentially improving the equity of access of Australians to affordable medicines, and
improving the equity of current pharmacy remuneration arrangements, such a reform would also have
the potential to improve production efficiency by:
enabling pharmacies to locate in those areas where there is the highest demand for the particular
types of medicines and services they supply, rather than being forced to locate in other areas that
are located a specified distance from the nearest existing pharmacy. As indicated in Table 11 in
2.1.3, the current location rules are still continuing to prevent per cent of new pharmacies in
major cities and inner regional areas, as well as per cent of relocating existing pharmacies in
outer regions of Australia, from locating in their preferred locations; and
reducing the extent to which the current location rules potentially shield less efficient pharmacies
from increased competition from other pharmacies that are able to supply those medicines in a
more efficient manner (by providing less efficient pharmacies with higher effective rates of
assistance than more efficient pharmacies). Although the current location rules might have
improved economic efficiency to some extent by reducing rent seeking activity, it appears that
those rules have done little to constrain the emergence of a large number of very small, less
efficient, pharmacies that are clustered around major population centres.
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What effect would the greater use of electronic prescriptions have on production efficiency?
As noted in section 2.1.3, another potential option for reform identified in the Review’s Interim Report
is to facilitate the increased, integrated, use of electronic prescriptions in order to replace the current,
less efficient, paper based scripts (Option 2.7).
As noted in section 2.1.1, although most Australians are currently able to order their medicines online,
there are several factors that constrain the extent to which this occurs in practice including the:
lack of awareness of this option and doubts regarding the legitimacy of such online supplies;
high administrative costs patients have to incur in order to use this option, particularly the
additional compliance costs they have to incur and time they have to wait for their medicines as a
result of the need to send a paper script to the online pharmacy; and
additional administrative costs that online pharmacies have to incur in order to process paper scripts.
Facilitating the increased use of electronic prescriptions has the potential to improve not only the
equity of access of Australians in the more remote regions of Australia to affordable medicines, but
also to improve the efficiency with which medicines are produced by pharmacies (increase production
efficiency) by:
reducing the administrative costs that pharmacies currently incur in order to process paper
scripts;
reducing the extent to which the current pharmacy location rules and ownership regulations
reduce the competition faced by less efficient pharmacies (since all pharmacies would face
increased competition from online pharmacies, thereby increasing the incentive to improve their
efficiency); and
increasing the extent to which all pharmacies can better utilise any spare capacity they might
have to supply additional medicines online (e.g. by increasing the ability of pharmacists to utilise
any of their spare capacity, or the capacity of their employees, capital equipment to provide
additional medicines and services to online customers).
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FISCAL SUSTAINABILITY
In addition to improving distributional equity and economic efficiency, the current pharmacy
remuneration and regulation are also intended to be fiscally sustainable over time.
This section:
identifies the intended fiscal sustainability of current pharmacy remuneration and regulation (the
projected fiscal cost of those arrangements and how the current arrangements are intended to
reduce those costs);
outlines available information on the actual economic sustainability of those arrangements (the
actual economic costs of funding current pharmacy remuneration and regulation, as opposed to
their fiscal costs); and
discusses the extent to which proposed changes to those current regulators and remuneration
arrangements are intended to improve both the fiscal sustainability and fundamental economic
sustainability of those arrangements.
4.1 Intended fiscal sustainability of current pharmacy remuneration and regulation
In addition to improving the equity of access to affordable medicines and reducing any perverse
effects that pharmacy remuneration and regulation arrangements might have on economic efficiency,
the National Medicines Policy also stresses the need for those arrangements to be financially
sustainable:
In attempting to balance health needs and responsible fiscal discipline, the partners will need to
address the following issues; that:
financing and supply arrangements for medicines optimise health outcomes and represent value
for money;
all partners take adequate responsibility for achieving value for money;
access to necessary medicines occurs at a cost the community as a whole can afford, particularly
in the context of pressures such as the development of new high cost medicines and Australia’s
ageing population;
access processes are made as simple and streamlined as possible, so that subsidisation of
medicines is timely, mechanisms are understood, and unnecessary administrative barriers and
expenses are avoided;
financing arrangements for medicines avoid incentives for cost-shifting between levels of
government or other funders, or other perverse incentives;
efficient and effective distribution and supply networks (distributors, hospital, and retail) exist; and
a fair distribution of costs and savings between the partners is achieved.7
7 Department of Health and Ageing (2000). National Medicines Policy, p2.
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The key instruments that the government uses to control the fiscal cost of the current pharmacy
remuneration arrangements are the:
negotiations that occur between pharmaceutical manufacturers and the government regarding the
pharmaceuticals to be listed on the PBS (the “price conditional subsidy” negotiations which
enable the government to list the more cost effective pharmaceuticals on the PBS);
Community Pharmacy Agreements that are negotiated between the Pharmacy Guild and the
government, which set the fees to be paid to pharmacists for supplying medicines on the
government’s behalf; and
regulations governing the location of pharmacies.
As indicated in Table 20, expenditure on pharmaceutical benefits and services is projected to
decrease in real terms by 0.1 per cent over the period 2016-17 to 2019-20 as a result of the
successful application of pricing policies that have reduced the cost of medicines listed on the PBS.
Table 20: Actual and projected fiscal costs of pharmaceutical benefits and services expenses
Source: Table 8.2, Commonwealth Budget 2016-17, Budget Paper No. 1, Statement 5: Expenses and Net
Capital Investment
Notes: The pharmaceutical benefits and services subfunction is expected to increase by 2.5 per cent in real
terms between 2015-16 and 2016-17 due largely to new and amended listings on the Pharmaceutical Benefits
Scheme (PBS), and growth in the use of exiting listings. Expenses are expected to decrease by 0.1 per cent in
real terms over the period 2016-17 to 2019-20 as a result of the successful application of pricing policies that
have reduced the cost of medicines listed on the PBS. Estimates for the PBS do not include the potential listing
of new medicines or unknown future price adjustments to existing listings, which typically result in net spending
above the original estimates.
2015-16 $10,362
2016-17 $10,800
2017-18 $10,989
2018-19 $11,322
2019-20 $11,722
TOTAL $55,195
YearFiscal cost
($m)
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Further information on:
total PBS expenditure by type of pharmacy is provided in Table 21;
average PBS expenditure by type of pharmacy is provided in Table 22; and
average PBS expenditure per script by type of pharmacy is provided in Table 23.
In addition, as noted in the submission to the Review from the Pharmacy Guild and illustrated in
Figure 11, PBS expenditure per script has been declining over time since 2009-10 and further
declines are projected over the period 2015-16 to 2019-20.
Figure 11: Parliamentary Budget Office projections of government pharmaceutical benefit expenditure per script
Source: Chart 4, p 36, Pharmacy Guild of Australia, Submission to Review of Pharmacy Remuneration and
Regulation
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4.2 Actual economic sustainability of current pharmacy remuneration and regulation
It is important to note, however, that these projected trends in the fiscal costs do not mean that the
current pharmacy remuneration arrangements are sustainable in the medium to longer term.
This is because the actual sustainability of current pharmacy remuneration and regulation, and the
extent to which they ultimately achieve their objectives of improving distributional equity and economic
efficiency, depends on the economic sustainability of those arrangements, not just their fiscal
sustainability.
The fiscal cost of current pharmacy remuneration and regulation is not the actual economic cost of
those arrangements to the nation as a whole.
Rather, this fiscal cost is a measure of the amount of income that has to be transferred from the
government to pharmacies each year to subsidise the provision of medicines to Australians (it is a
transfer of income from one section of the community to another).
The actual economic cost of raising that revenue is equal to the sum of the:
“opportunity cost” of the real value of resources that is invested in the supply of subsidised
medicines to Australians (the social rate of return that the national as a whole could have derived
if those funds had been invested instead in the next best investment from the nation’s point of
view); and
“deadweight cost” of raising the revenue required to fund that investment through increased
taxation or government borrowing (which is, in effect, just deferred taxation to the extent that
higher levels of taxation are required to repay the principal and interest on that debt). In the
course of raising revenue, the tax system does not just redistribute revenue from one section of
the community (taxpayers) to another (the government). Rather, it imposes a real economic cost
on the nation as a whole by unintentionally altering consumption, production, investment and
resource use decisions, thereby encouraging a less efficient use of the nation’s resources. That
is, the economic cost of raising each dollar of revenue (e.g. through the tax system, or through
government borrowing) exceeds the amount of revenue raised by an amount referred to as the
“excess burden” or “deadweight cost” of taxation.
The opportunity cost of the real resources that are invested by the government are typically taken into
account in cost benefit analyses of those investments through the use of a real discount rate that
takes into account the social opportunity cost of government expenditure (e.g. a 7% real rate of return
is often used to evaluate the opportunity cost of State infrastructure investments). By contrast, the
deadweight costs of raising the revenue are often overlooked when evaluating the economic costs of
government projects and programs. This report uses the approach adopted by the NZ Treasury to
evaluate government projects and programs funded using taxation revenue, which assumes that the
deadweight costs are 20 per cent of the amount of that investment.
Table 24 presents estimates of the actual and projected economic costs of pharmaceutical benefits
and services expenses using this approach.
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Table 24: Actual and projected economic costs of pharmaceutical benefits and services expenses
Source: Commonwealth Budget 2016-17 data
4.3 Effects of proposed changes to current arrangements on fiscal sustainability
4.3.1 Effects of introducing a flat fee for dispensing on the fiscal costs of remunerating pharmacies
The potential savings in fiscal costs of remunerating pharmacies arising from the introduction of a flat
dispensing fee in the range from $9.00 to $11.50 per script (e.g. set at an illustrative level of $10 per
script) are set out in Table 25.
Specifically, Table 25 suggests that the introduction of a $10 flat fee for dispensing could potentially
save:
$1.5b of fiscal costs over the period 2015-16 to 2019-20; or
$1.9b of economic costs over the period 2015-16 to 2019-20.
Table 25: Fiscal and economic cost savings from a $10 flat fee per script
Source: PBS and Commonwealth Budget 2016-17 data
Notes:
1. A $10 flat fee was selected for illustrative purposes from within the proposed range as set out in Option 4.3 2. Fiscal cost savings based on 2016 PBS data and excludes chemotherapy remuneration 3. See Table 26 for fiscal cost savings for 2015-16
As indicated in Table 26, most of the savings in fiscal costs would come from:
small pharmacies ($189.2m in 2015-16); and
micro pharmacies ($73.8m in 2015-16).
Opportunity cost
($m at 7%)
Deadweight cost
($m at 20%)
Total economic cost
($m)
2015-16 $10,362 $725 $2,072 $13,160
2016-17 $10,800 $756 $2,160 $13,716
2017-18 $10,989 $769 $2,198 $13,956
2018-19 $11,322 $793 $2,264 $14,379
2019-20 $11,722 $821 $2,344 $14,887
TOTAL $55,195 $3,864 $11,039 $70,098
YearFiscal cost
($m)
Economic cost
Opportunity cost
(7%)
Deadweight cost
(20%)
Total economic
cost saving
2015-16 $277,693,429 $19,438,540 $55,538,686 $352,670,655
2016-17 $290,328,480 $20,322,994 $58,065,696 $368,717,170
2017-18 $296,564,010 $20,759,481 $59,312,802 $376,636,293
2018-19 $303,674,132 $21,257,189 $60,734,826 $385,666,148
2019-20 $310,954,719 $21,766,830 $62,190,944 $394,912,493
TOTAL $1,479,214,770 $103,545,034 $295,842,954 $1,878,602,758
Year Fiscal cost savings
Economic cost savings
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4.3.2 Effects of introducing a flat fee for dispensing on the economic costs of remunerating pharmacies
It is important to note that the fiscal cost savings outlined above underestimate the savings in
economic costs that the nation as a whole would derive from the introduction of a flat dispending fee
(e.g. set at $10 per script), which are also set out in Table 25. Specifically, Table 25 suggests that the
introduction of a $10 flat fee for dispensing could:
save $352.7m economic costs in 2015-16, which would comprise a:
$19.4m saving in the opportunity cost of the ability of the government to invest the fiscal cost
savings of $277.7m and earn a 7 per cent real rate of return on that investment; and
$55.5m saving in the deadweight costs as a result of not having to raise the fiscal cost
savings of $277.7m through taxation;
save $1.9b of economic costs over the period 2015-16 to 2019-20, which would comprise a:
$103.5m saving in the opportunity cost of the ability of the government to invest the fiscal cost
savings of $1.48b and earn a 7 per cent real rate of return on that investment; and
$295.8m saving in the deadweight costs as a result of not having to raise the fiscal cost
savings of $1.48b through taxation.
4.3.3 Other potential approaches to mitigating and managing fiscal and economic costs arising from the current pharmacy remuneration arrangements
Providing pharmacies with a flat fee for dispensing is not the only potential reform that could be used
to improve the financial sustainability of the current pharmacy remuneration arrangements.
Another potential option for reform would be to develop and implement a detailed “performance based
contract” between government and pharmacies along the lines of existing contracts for other essential
services.
For example, the contracts between the NSW government and the suppliers of rural and regional bus
services illustrate many of the key features that you would expect to see outlined in the contract
between pharmacies in Australia and the Commonwealth government8, including:
a clear outline of the types, quantities and quality of services that are expected to be supplied on
behalf of the government;
detailed key performance indicators that are to be used in order to assess the extent to which
each provider is achieving the government’s objectives;
a detailed formula that is to be used to calculate the level of remuneration that is to be paid to
each provider to compensate them for the efficient long run marginal costs of supplying services
on behalf of the government. This includes:
the identification of benchmarks that are to be used for the purposes of estimating the efficient
cost of service delivery; and
8 See for example Rural & Regional Bus Service Contract, Contract A, http://www.transport.nsw.gov.au/sites/default/files/b2b/bus/rural-and-regional-contract-a.pdf and Contract B http://www.transport.nsw.gov.au/sites/default/files/b2b/bus/rural-and-regional-contract-b.pdf
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appropriate indexes that are to be used each year to adjust for the effects of inflation;
detailed financial reporting requirements, which include the requirement for providers to supply
the government with copies of their tax returns each year in order to enable the government to:
identify those providers that might be in financial difficulties, which could leave the industry
and cause problems with the continuity of supply of services in the more remote regions of
Australia; and
identify those providers that might be deriving economic rents under the current remuneration
arrangements (rates of return that are greater than normal rates of return;
profit and risk sharing arrangements between providers and the government.
Indeed, as noted by Mellish and MacDonald (2009)9, the NSW Rural and Regional Reforms of bus
funding provide a good example of how government and industry can move from a position of
adversarial negotiations to the development of a trusted partnership.
The implementation of a number of the options for reform set out in the Interim Report would help
establish the foundations for such a performance based contract between the government and
pharmacies, including the implementation of the following options:
Option 3.1: Community Pharmacies – Minimum Services. The government should establish a
process to determine the set of minimum requirements that a community pharmacy must meet in
order to receive remuneration for dispensing. The government should initiate procedures to
enforce these requirements and to have them updated at regular intervals. These requirements
should be promoted by being incorporated within the Community Pharmacy Service Charter;
Option 4.1: Accounting Information. 4.1. As soon as possible following the completion of this
Review, the government in consultation with the Guild and other stakeholders should:
Determine a set of accounting principles that will apply for community pharmacies in order to
provide the relevant information needed to determine the best practice benchmark cost of a
dispense (as these terms are defined in this report).
Require community pharmacy (as a condition of being approved to dispense PBS medicines)
to provide the necessary accounting information to inform consideration in the development of
each CPA (including as a basis for the determination of a best practice pharmacy). The
relevant accounting information should be provided for each financial year, and no later than
December 31 of the following financial year (beginning with December 31, 2018).
Designate a body within the government (although potentially an existing independent
statutory authority with the relevant expertise such as the Pharmaceutical Benefits
Remuneration Tribunal, or, more broadly, the ACCC) to provide a recommendation to the
government on the best practice benchmark cost of a dispense as required over time by the
government. The first such advice is to be provided as soon as practical and certainly before
9 Mellish, D. and MacDonald I, (2009). A study of a trusting partnership between government and industry, Working Paper,
Board of Advice ITLS-BoA-WP-09-02 September 2009.
http://sydney.edu.au/business/ data/assets/pdf file/0004/46363/ITLS-BoA-WP-09-02.pdf. See also Mellish, MacDonald,
Dwyer, (2008). A journey from adversary to partnership bus reform in NSW
http://isiarticles.com/bundles/Article/pre/pdf/3447.pdf
87
the end of 2019. The timing of later determinations will depend on the process used in the
future by the government to set the remuneration for dispensing PBS medicines.
The information and advice submitted to the government should form the basis for the
average remuneration for a ‘dispense’ to community pharmacy in the future and certainly from
the expiration of the 6 CPA. The provision of appropriate accounting information should be an
ongoing requirement to support the development of each CPA.
Option 4.2: Remuneration to be Based on Efficient Cost of Dispensing. The remuneration for
dispensing paid by government and patient co-payments to community pharmacy should be
based on the costs of dispensing for an efficient pharmacy; and
Option 4.4: Remuneration for Dispensing – Formula. The remuneration for dispensing should be a
simple dispense fee based on the efficient, average, long-run incremental cost of a dispense in a
community pharmacy.
88
Table 26: Average PBS expenditure per script 2015/16
Notes:
1. Based on 2015-16 PBS data
2. Excludes chemotherapy fees
3. Includes pharmacies operating part-year
4. Includes all patient categories
5. Includes community pharmacy only
6. Pharmacy remuneration = dispensing fee + AHI + dangerous drug fee + electronic prescription fee + other fees
Total Pharmacy
Remuneration
Average
Pharmacy
Remuneration
Average
Pharmacy
Remuneration
per Script
Proposed
Fee per
Dispense
per Script
Proposed Total
Pharmacy
Revenue
Proposed
Average
Pharmacy
Revenue
Total Impact on
Pharmacy
Revenue
Average Impact
on Pharmacy
Revenue per
Pharmacy
Fiscal Impact
(Government
Saving)
Micro - 1,600,000 901,318,789 258,110 11.25 10.00 801,103,940 229,411 100,214,849 28,698 73,842,940
Small 1,600,000 8,000,000 2,301,055,674 880,955 11.28 10.00 2,039,070,770 780,655 261,984,904 100,300 189,175,504
Medium 8,000,000 16,000,000 62,809,171 1,427,481 11.69 10.00 53,734,370 1,221,236 9,074,801 206,245 6,780,728
Large 16,000,000 32,000,000 25,816,304 1,290,815 13.03 10.00 19,809,750 990,488 6,006,554 300,328 4,949,720
Very Large 32,000,000 999,999,999 8,024,459 1,604,892 18.08 10.00 4,439,320 887,864 3,585,139 717,028 2,944,537
3,299,024,397 534,428$ 11.31$ 10.00$ 2,918,158,150 472,729 380,866,247$ 61,699$ 277,693,429
Annual saving 3.17%
CURRENT PROPOSED
Pharmacy Size
by PBS RevenueMin Max
89
APPENDICES
90
Appendix 1: Number and location of pharmacies and the socio-economic status of the regions they serve
Figure 12: Distribution of pharmacies across Victoria and Southern NSW
Source: PBS data
Notes: The areas shaded in red indicate areas of lower socio economic status and the blue shaded areas indicate areas of higher socio-economic status.
The yellow circles indicate the number of pharmacies in the relevant area.
91
Figure 13: Distribution of pharmacies across Melbourne
Source: PBS data
Notes: The areas shaded in red indicate areas of lower socio economic status and the blue shaded areas indicate areas of higher socio-economic status.
The yellow circles indicate the number of pharmacies in the relevant area.
92
Figure 14: Distribution of pharmacies across Canberra
Source: PBS data
Notes: The areas shaded in red indicate areas of lower socio economic status and the blue shaded areas indicate areas of higher socio-economic status.
The yellow circles indicate the number of pharmacies in the relevant area.
93
Figure 15: Distribution of pharmacies across Darwin
Source: PBS data
Notes: The areas shaded in red indicate areas of lower socio economic status and the blue shaded areas indicate areas of higher socio-economic status.
The yellow circles indicate the number of pharmacies in the relevant area.
94
Figure 16: Distribution of pharmacies across Brisbane
Source: PBS data
Notes: The areas shaded in red indicate areas of lower socio economic status and the blue shaded areas indicate areas of higher socio-economic status.
The yellow circles indicate the number of pharmacies in the relevant area.
95
Figure 17: Distribution of pharmacies across Adelaide
Source: PBS data
Notes: The areas shaded in red indicate areas of lower socio economic status and the blue shaded areas indicate areas of higher socio-economic status.
The yellow circles indicate the number of pharmacies in the relevant area.
96
Figure 18: Distribution of pharmacies across Perth
Source: PBS data
Notes: The areas shaded in red indicate areas of lower socio economic status and the blue shaded areas indicate areas of higher socio-economic status.
The yellow circles indicate the number of pharmacies in the relevant area.
97
Figure 19: Distribution of pharmacies across Hobart
Source: PBS data
Notes: The areas shaded in red indicate areas of lower socio economic status and the blue shaded areas indicate areas of higher socio-economic status.
The yellow circles indicate the number of pharmacies in the relevant area.
98
Appendix 2: Summary of financial data
This appendix summarises the pharmacy financial data that was available to the Review at the time
this report was prepared.
In order to make data as comparable as possible, it has been presented using the same format. As a
result, it has been necessary to make some adjustments to that data. In isolated cases, ranges within
the data sets were presented for illustrative purposes. For the purposes of the financial model
presented in Appendix 3, data were selected from within the data ranges to represent a profitable
pharmacy.
In general, the availability of data decreased as the size of the pharmacies increased. While this may
be due to a number of reasons, the majority of pharmacies fall into the micro and small categories. It
is also important to note that all data sources are at an aggregated level except for the financial
survey responses, which is evident in the vast range of data contained in the survey fields. A small
number of the responses from the financial survey were excluded from the data comparison tables
due to what appeared to be data entry errors.
The various data sources were used to construct a model that sought to link the various financial data
sources at an aggregate level with PBS data. The reason for this is that there is little information
available on script volume, remuneration per script, cost per script, type of medicines, PBS and non-
PBS activities and how each of these interrelate and contribute to total revenue and costs (profit). For
example, a specialist pharmacy that dispenses a larger proportion of high cost drugs might have
similar total revenue to a pharmacy that dispenses high volumes of low cost medicine, but their
revenue and cost structures may be quite different. The model, in conjunction with other sections of
the report sought to highlight some of these aspects. However, the data limitations provide significant
barriers to the visibility of these and other differences.
The tables are set out according to pharmacy size by total revenue as follows:
Micro: $0 - $2m;
Small: $2m - $10m;
Medium: $10m – $20m;
Large: $20m - $40m;
Very Large: $40m +.
PBS data:
Where PBS data was required to be classified into each of the above categories, it was assumed for
simplicity that PBS revenue comprised 80% of total revenue (sales mix). The PBS revenue of
pharmacies was therefore classified as follows:
Micro: $0 - $1.6m;
Small: $1.6m - $8m;
Medium: $8m – $16m;
Large: $16m - $32m;
Very Large: $32m +
99
PBS data and sales mix:
A consistent sales mix percentage was required to avoid overlap or gaps in the categories used to
classify the PBS data. This also allowed the results to be easily reconciled back to the aggregated
PBS dataset. Although the industry average sales mix is around 70% (PBS revenue comprises
70% of total revenue), the percentage was chosen that best aligns the total number of
pharmacies in each category to the PBS dataset to the data set. This percentage was
80%. While there is some evidence apparent from the data available that sales mix decreases as
pharmacy size increases the model has maintained a sales mix of 80% across all pharmacy sizes
for simplicity and comparability. In particular, the data sources available primarily related to micro
and small pharmacies, which made an accurate study of the relationship between pharmacy size
and sales mix across all pharmacy sizes unlikely.
Figure 20: The relationship between profit and sales mix
Source: Guild Digest 2016, , Benchmarking.com.au
Accordingly, it was of interest to understand the interdependency of sales mix and profitability. In
this regard there were conflicting data sources (see Figure 20). These conflicts may be
attributable to a number of reasons, including sample size and unrepresentative samples. In this
regard the certain data sources seemed to suggest that profitability decreased as sales mix
increased, while others showed the opposite. The results of any sensitivity analysis performed
around sales mix is dependent on which data source is used in the assumptions of the model.
This inconsistency was overcome in the financial model by using the data to determine
the gross profit for each model category. The result is that the appropriate sales mix is indirectly
built into the gross profit inputs and is less sensitive to manual changes to sales mix changes.
The PBS data section in the data comparison tables represents the average remuneration per script
at a pharmacy level across all pharmacies. The upper limit of $28.03 indicates that there is at least
one pharmacy that on average receives $28.03 remuneration per script. Importantly, there is only a
very limited number of pharmacies with an average remuneration per dispense of above $12, with the
majority of pharmacies receiving between $11 and $12 per script. High revenue per script is driven
primarily by sales of high cost medicines, indicating that a limited number of pharmacies dispense a
100
relatively high proportion of high cost scripts. Figure 28 in Appendix 7 illustrates how the range of
average remuneration per pharmacy changes over the years 2012-13 to 2016-17.
Notes to tables in this appendix:
1. AOS: After owners’ salary
2. BOS: Before owners’ salary3. Field colour: Imputed from other data sources or calculated
4. Field colour: Estimate5. total expenses and net income assumed to be after owners’ salaries6. The PBS data ranges for remuneration per script are averages per pharmacy. It excludes
remuneration for chemotherapy.7. Net assets includes goodwill
8. Data sources and relevant financial years included are: data on pharmacy assets 2015-16 ( )
Guild Digest (Guild) 2014-15
Benchmarking.com.au 2015-16 Bruce Annabel (spans multiple periods)
Interim report (draft options at time if writing) PBS data 2015-16 Financial survey 2015-16
106
Appendix 3: Detailed financials for the different types of pharmacies
.
This appendix outlines the detailed financial model that has been developed for each of the key types
of pharmacies using the available pharmacy financial data outlined in Appendix 2.
It contains key items of interest for both PBS and non-PBS pharmacy activities and aims to provide
some insight as to how these activities interrelate and contribute to pharmacy revenue, costs and
profitability.
Notes to tables in this appendix:
1. AOS: After owners’ salary
2. BOS: Before owners’ salary 3. Includes pharmacies with active approval numbers for the full 2015-16 financial year only 4. Excludes pharmacies that supply chemotherapy drugs
107
Table 32: Financial summary for profitable and taxable pharmacies
Source: Pharmacy financial data outlined in Appendix 2
CURRENT STATE
Pharmacy Financial Summary Micro Small Medium Large22,891 78,229 160,706 127,493
REVENUE PBS PBS SCRIPT REVENUE 790,927 2,844,232 10,003,291 21,408,276
Average remuneration per script 11.25 11.28 11.63 13.63
PBS GROSS PROFIT Value 257,588 882,649 1,868,968 1,737,133
Percentage % 0.33 0.31 0.19 0.08
NON-PBS NON-PBS REVENUE 197,732 711,058 2,500,823 5,352,069
Sales mix (PBS %) 80% 80% 80% 80%
NON-PBS GROSS PROFITValue 88,979 319,976 631,855 2,009,315
Percentage % 45% 45% 25% 38%
TOTAL REVEN 988,659 3,555,290 12,504,114 26,760,344
GROSS PROFIT Value 346,567 1,202,625 2,500,823 3,746,448
Percentage % 39% 38% 20% 14%
EXPENSES PBS Salaries and Wages 77,407 289,667 529,150 330,818
Superannuation 7,148 26,750 48,866 30,551
Rent Paid 24,438 91,451 167,059 104,443
Total Other Expenses 68,783 257,395 470,196 293,961
ATTRIBUTABLE TO PBS (aos) 177,777 665,263 1,215,271 759,772
PBS cost allocation per script 7.77 8.50 7.56 5.96
NON-PBS Salaries and Wages 26,739 105,010 178,893 382,652
Superannuation 2,469 9,698 16,521 35,337
Rent Paid 8,442 33,153 56,479 120,807
Total Other Expenses 23,760 93,310 158,962 340,020
ATTRIBUTABLE TO NON-PBS (aos) 61,410 241,170 410,855 878,816
PBS & NON-PBSInterest Paid 8,848 33,530 60,152 60,613
Depreciation 7,389 28,000 50,232 50,617
OTHER PROPRIETOR'S SALARY 84,739 93,362 125,041 214,083
170,686 874,601 1,611,470 1,535,736
255,424 967,964 1,736,512 1,749,819
NET PROFIT (bos) Value 175,882 328,023 889,352 2,210,712
Percentage % 17.79% 9.23% 7.11% 8.26%
NET PROFIT (aos) Value 91,143 234,661 764,311 1,996,629
Percentage % 9.22% 6.60% 6.11% 7.46%
192,118 389,553 999,736 2,321,941
107,380 296,191 874,695 2,107,858
NET ASSETS 835,949 2,923,634 9,878,250 15,788,603
23% 13% 10% 15%
13% 10% 9% 13%
EFFECTIVE RATE OF ASSISTANCE 32% 21% 40% 108%
Profitable Taxable
Average Script Volume
USER COST OF CAPITAL (aos)
TOTAL EXPENSES bos
TOTAL EXPENSES aos
EBITDA (bos)
EBITDA (aos)
USER COST OF CAPITAL (bos)
108
Table 33: Financial summary for profitable and non-taxable pharmacies
Source: Pharmacy financial data available to the Review
CURRENT STATE
Pharmacy Financial Summary Micro Small Medium Large22,891 78,229 160,706 127,493
REVENUE PBS PBS SCRIPT REVENUE 790,927 2,844,232 10,003,291 21,408,276
Average remuneration per script 11.25 11.28 11.63 13.63
PBS GROSS PROFIT Value 257,588 882,649 1,868,968 1,737,133
Percentage % 0.33 0.31 0.19 0.08
NON-PBS NON-PBS REVENUE 197,732 711,058 2,500,823 5,352,069
Sales mix (PBS %) 80% 80% 80% 80%
NON-PBS GROSS PROFITValue 88,979 319,976 Not available Not available
Percentage % 45% 45% Not available Not available
TOTAL REVEN 988,659 3,555,290 12,504,114 26,760,344
GROSS PROFIT Value 346,567 1,202,625 Not Available Not Available
Percentage % 39% 38% Not Available Not Available
EXPENSES PBS Salaries and Wages 92,807 378,718 Not available Not available
Superannuation 8,571 34,974 Not available Not available
Rent Paid 29,300 119,565 Not available Not available
Total Other Expenses 82,467 336,524 Not available Not available
ATTRIBUTABLE TO PBS (aos) 213,145 869,781 Not Available Not Available
PBS cost allocation per script 9.31 11.12 Not Available Not Available
NON-PBS Salaries and Wages 32,059 137,292 Not available Not available
Superannuation 2,961 12,679 Not available Not available
Rent Paid 10,121 43,345 Not available Not available
Total Other Expenses 28,487 121,996 Not available Not available
ATTRIBUTABLE TO NON-PBS (aos) 73,627 315,312 Not available Not available
PBS & NON-PBSInterest Paid 10,608 43,837 Not available Not available
Depreciation 8,859 36,608 Not available Not available
OTHER PROPRIETOR'S SALARY 84,739 93,362 Not available Not available
221,500 1,172,177 Not available Not available
306,239 1,265,540 Not Available Not Available
NET PROFIT (bos) Value 125,067 30,447 Not available Not available
Percentage % 12.65% 0.86% Not available Not available
NET PROFIT (aos) Value 40,329 (62,915) Not Available Not Available
Percentage % 4.08% -1.77% Not Available Not Available
144,534 110,893 Not available Not available
59,795 17,530 Not available Not available
NET ASSETS 835,949 2,923,634 Not available Not available
17% 4% Not available Not available
7% 1% Not Available Not Available
EFFECTIVE RATE OF ASSISTANCE 10% -8% Not Available Not Available
Profitable Non-Taxable
Average Script Volume
USER COST OF CAPITAL (aos)
TOTAL EXPENSES bos
TOTAL EXPENSES aos
EBITDA (bos)
EBITDA (aos)
USER COST OF CAPITAL (bos)
109
Table 34: Financial summary for non-profitable pharmacies
Source: Pharmacy financial data available to the Review
CURRENT STATE
Pharmacy Financial Summary Micro Small Medium Large22,891 78,229 160,706 127,493
REVENUE PBS PBS SCRIPT REVENUE 790,927 2,844,232 10,003,291 21,408,276
Average remuneration per script 11.25 11.28 11.63 13.63
PBS GROSS PROFIT Value 257,588 882,649 1,868,968 1,737,133
Percentage % 0.33 0.31 0.19 0.08
NON-PBS NON-PBS REVENUE 197,732 711,058 2,500,823 5,352,069
Sales mix (PBS %) 80% 80% 80% 80%
NON-PBS GROSS PROFITValue 88,979 319,976 631,855 2,009,315
Percentage % 45% 45% 25% 38%
TOTAL REVEN 988,659 3,555,290 12,504,114 26,760,344
GROSS PROFIT Value 346,567 1,202,625 2,500,823 3,746,448
Percentage % 39% 38% 20% 14%
EXPENSES PBS Salaries and Wages 151,095 446,171 834,040 1,038,153
Superannuation 13,953 41,203 77,023 95,872
Rent Paid 47,702 140,861 263,316 327,756
Total Other Expenses 134,261 396,462 741,119 922,490
ATTRIBUTABLE TO PBS (aos) 347,012 1,024,698 1,915,498 2,384,272
PBS cost allocation per script 15.16 13.10 11.92 18.70
NON-PBS Salaries and Wages 52,193 161,745 281,970 1,200,816
Superannuation 4,820 14,937 26,040 110,894
Rent Paid 16,478 51,065 89,021 379,111
Total Other Expenses 46,378 143,725 250,555 1,067,031
ATTRIBUTABLE TO NON-PBS (aos) 119,869 371,472 647,585 2,757,851
PBS & NON-PBSInterest Paid 17,270 51,645 94,810 190,211
Depreciation 14,422 43,128 79,175 158,842
OTHER PROPRIETOR'S SALARY 84,739 93,362 125,041 214,083
413,836 1,397,583 2,612,029 5,277,099
498,575 1,490,945 2,737,070 5,491,182
NET PROFIT (bos) Value (67,269) (194,958) (111,207) (1,530,651)
Percentage % -6.80% -5.48% -0.89% -5.72%
NET PROFIT (aos) Value (152,007) (288,320) (236,248) (1,744,734)
Percentage % -15.38% -8.11% -1.89% -6.52%
(35,576) (100,184) 62,778 (1,181,598)
(120,315) (193,547) (62,263) (1,395,681)
NET ASSETS 835,949 2,923,634 9,878,250 15,788,603
-4% -3% 1% -7%
-14% -7% -1% -9%
EFFECTIVE RATE OF ASSISTANCE -33% -22% -11% -34%
Not Profitable
Average Script Volume
USER COST OF CAPITAL (aos)
TOTAL EXPENSES bos
TOTAL EXPENSES aos
EBITDA (bos)
EBITDA (aos)
USER COST OF CAPITAL (bos)
110
Appendix 4: Benchmarking of micro pharmacies against other comparable businesses
Table 35 below outlines how key profit and loss items, inventory and trading hours for micro community pharmacies
compare against other similarly sized business. The businesses chosen as benchmarks resemble characteristics that
make them reasonable for use as benchmarks.
It can be seen that with the exception of general practitioners, profitable micro pharmacies appear to earn higher net
profit margins than the benchmark businesses. Gross profit also tend to be higher for pharmacies than the
benchmarks, this may be due to higher gross margins on non-PBS products than on normal grocery items that would
be supplied by corner stores and supermarkets. Another interesting observation is that pharmacies have high stock
levels and low stock turn rates compared with its benchmarks. In this regard it is important to note that this cannot
simply be attributed to PBS stock as pharmacies carry varying levels of non-PBS stock and it is not possible to isolate
PBS from non-PBS from the data available.
Table 35: Benchmarking of micro pharmacies against other comparable businesses
Source: Pharmacy financial data available to the Review and Benchmarking.com.au
Pharmacy
Range Min
Pharmacy
Range
Max
RSM
Profitable
BM.com.au
Cornerstore
≥$600k
BM.com.au
Health Food
Retailers
≥$650k
BM.com.au
General
Practitioners
$750k to $1.5m
BM.com.au
Supermarkets
< $1.5m
SALES, EXPENSES &
PROFITABILITY
SALES 1,431,537 1,323,803 1,097,108 787,537
COST OF GOODS SOLD 50% 82% 61% 67% 55% N/A 68%
GROSS MARGIN 18% 50% 39% 33% 45% 32%
TOTAL REVENUE
EXPENSES
Salaries and Wages 0.5% 108.7% 11.4% 12.1% 37.6% 9.1%
Rent Paid 0.2% 29.0% 3.2% 5.7% 6.2% 3.2%
TOTAL EXPENSES (bos) 17.3% 41.9% 17.3%
TOTAL INCOME (bos) -3.6% 21.6% 21.6% 9.6% 9.5% 38.1% 8.9%
EBITDA (bos) 0.5% 34.7% 25.2% 11.7% 13.0% 41.7% 12.6%
INVENTORY ANALYSIS
STOCK CARRIED 7.2% 14.8% 3% 10.8% N/A 5%
STOCK TURN 4.37 8.61 26 5 N/A 14
STATISTICS
TOTAL HOURS OPEN per WEEK 37 81 81 46 50 55
Item
Micro ($0-$2m)
111
Appendix 5: Selected methodologies
The PBS database is large and complex. Accordingly, there is considerable complexity involved in extracting the
correct information from the PBS database.
This appendix section outlines the methodologies used for some of the key PBS data analyses that this report
contains. These include the methodologies that are relevant to the:
analysis of locations of patients, pharmacies and prescribers;
analysis of top 10 over co-payment medicines;
analysis of top 10 under co-payment medicines;
nominal rate of assistance to patients from price variations;
effect of price variation by pharmacy type and PhARIA;
patient gain or loss from price variation and $1 discount;
distribution of e-script uptake and dangerous drug dispensing in pharmacies; and
distribution of high cost medicine in pharmacies.
These methodologies were developed working in collaboration with the Department of Health’s data team.
Analysis of locations of patients, pharmacies and prescriber
Table 1: Location of patient, prescriber and pharmacy by type of patient Location of consumer, prescriber and pharmacy
Consumer
and
pharmacy in
same
postcode
Prescriber
and
pharmacy in
same
postcode
Consumer,
prescriber
and
pharmacy in
same
postcode
Consumer,
prescriber
and
pharmacy in
different
postcodes
Concessional non-safety net 145,061,002 49% 58% 53% 37% 26%
Conessional safety net 43,712,612 15% 63% 53% 40% 24%
General non-safety net (over co-payment) 14,486,038 5% 45% 41% 23% 37%
General non-safety net (under co-payment) 80,762,096 27% 46% 47% 28% 34%
General safety net 3,192,802 1% 58% 46% 32% 28%
RPBS non-safety net 7,408,118 2% 59% 53% 39% 27%
PRBS safety net 2,936,671 1% 47% 53% 31% 31%
Prescriber Bag 382,285 0% 0% 72% 0% 27%
ALL 297,941,624 100% 55% 51% 34% 29%
Patient typeNumber of
scripts
Percentage
of total
scripts
117
Analysis of top ten under co-payment medicines
Table 5: Differences in the prices paid by general patients per pack for the top 10 under co-payment medicines (September 2016)
Figure 9: Frequency distribution of the price paid by general patients in September 2016 for the top 10 under co-payment medicines
01215Y PARACETAMOL + CODEINE $11.36 86 $11.41 $4.78
01394J LEVONORGESTREL + ETHINYLOESTRADIOL $18.28 101 $16.08 $5.2401889K AMOXYCILLIN $11.89 176 $12.01 $4.8803119E CEPHALEXIN $12.13 158 $12.66 $4.9508008L PANTOPRAZOLE $14.05 99 $11.81 $4.9908215J ATORVASTATIN $15.85 74 $13.06 $5.9908254K AMOXYCILLIN + CLAVULANIC ACID $13.33 186 $13.66 $5.4508600P ESOMEPRAZOLE $24.09 112 $21.00 $6.3008700X ESCITALOPRAM $13.50 74 $12.46 $5.8009043Y ROSUVASTATIN $21.39 202 $17.22 $6.46
Standard
deviation of
actual price
to
consumer
per pack
Average
actual price
paid by
consumer
per pack
Scripts
('000)Item Code Drug Name
Dispensed
Price at
Maximum
Quantity
(DPMQ)
124
Distribution of pharmacies’ e-script uptakes and distribution of pharmacies dangerous drug proportion of total PBS scripts
Figure 31: Scatter plots – percentage of e-scripts vs percentage of dangerous drug scripts
Each dot represents a pharmacy.
There is a very large variance in
the proportion of e-scripts over
all PBS scripts, ranging from 0%
to 80%.
The variance in proportion of
dangerous scripts are much
smaller from 0% to 10% for the
majority of pharmacies.
Figure 32: Distribution of percentage of dangerous drug scripts by PhARIA
126
Distribution of pharmacies high cost medicine proportion of total PBS scripts
Figure 30: Distribution of proportion of high cost medicine sales across pharmacies in different PhARIA
Each dot represents a pharmacy.
Figure 29: Distribution of the value of high cost medicine sales expressed as a proportion of total PBS sales across pharmacies
129
Appendix 6: RPMA case studies
Postcode 2680
In the locality of Griffith, NSW, 6 pharmacies have received RPMA payments for the 2015-16 financial year with
a total value of $47,021. All pharmacies in this locality are classified as PhARIA 2 pharmacies. It appears that
not all pharmacies in the locality are receiving RPMA payments. The reason for this is not clear, but could be
due to the following factors:
Pharmacies are required to apply and not all eligible pharmacies may have applied for RPMA payments
Eligibility for RPMA reduces as script volume increases, for the relevant PhARIA rating of the pharmacy
Figure 24: Pharmacies in Griffith locality (Postcode 2680)
Source: Publicly available on Google Maps
Figure 25: Postcode area 2680
130
Postcode 0870
In the locality of Alice Springs, NT, pharmacies have received RPMA payments for the 2015-16 financial year
with a total value of $ . All pharmacies in this locality are classified as PhARIA 5 pharmacies.
Figure 26: Pharmacies in Alice Springs locality (Postcode 0870)
Source: Publicly available on Google Maps
Figure 27: Postcode area 0870
131
Postcode data
Table 36: RPMA postcode case study: summary of pharmacies within postcodes receiving RPMA
Source: The Department of Health
Notes:
1. RPMA payments analysed for 2015-162. PhARIA and postcode data have been obtained from de-identified and cleansed $1 discount and prescription data sets
provided by the Department of health. These data sets contains 2014-15 PhARIA values. 3. Some discrepancies have been noted in the provided data and note that further work is required to provide an accurate
representation of RPMA payments as a whole. The case studies are not materially affected by these discrepancies. 4. PhARIA ratings for pharmacies can vary considerably within some postcodes, e.g. postcode 4702 contains pharmacies
that range from PhARIA 1 to PhARIA 6.
Conclusion
It appears that there are pharmacies within close vicinity of each other that are receiving RPMA payments.
According to The Department of Health the purpose of the RPMA is as follows: “The Rural Pharmacy
Maintenance Allowance (RPMA), available from 1 January 2001, provides ongoing support to pharmacies in
rural and remote communities. In recognition of the additional financial burden of maintaining a pharmacy in rural
and remote locations this monthly allowance assists these pharmacies to continue to provide quality
pharmaceutical services.
Payments are structured to provide an increased level of assistance to areas of greater need, taking into
account the relative remoteness of the pharmacy according to the Pharmacy ARIA, and the level of that
pharmacy's PBS and RPBS claimable processed prescriptions paid by the Medicare.” 10
The 6 CPA outlines its purpose as “... to support improved access to PBS medicines and pharmacy services for
people in rural and remote regions of Australia, through the provision of a support allowance which recognises
the additional financial burden of maintaining a pharmacy in these areas.”11
This raises the question as to whether the existence of clustered RPMA recipients aligns with the intended
purpose of the RPMA program. For example, in the case study above on postcode 2680 (Griffith locality), not all
of the pharmacies receive RPMA payments. However, firstly there are a large number of pharmacies in this
locality and secondly, not all of these pharmacies are receiving RPMA payments. Without being privy to the
financial information of each of the pharmacies in this locality, it appears as though some pharmacies are viable
in this locality without the RPMA. The high number of pharmacies could potentially also indicate that setting up a
pharmacy in this locality is not RPMA dependent.
10 The Department of Health, http://www.health.gov.au/internet/main/publishing.nsf/Content/health-pbs- general-pharmacy.htm, accessed 24 March 2017
11 6 CPA, http://6cpa.com.au/rural-support-programmes/rural-pharmacy-maintenance-allowance, accessed 24 March 2017
Financial
Year
Pharmacy
PostcodeLocality
TOTAL
NUMBER
OF
PHARMACIES
Number of
pharmacies
claiming
RPMA
Total
PresciptionsRPMA
2680 Griffith 10 6 47,021$
2015-16
132
Interestingly, the stated objective of the RPMA (as per The Department of Health above) is not to incentivise the
establishment of pharmacies in rural and remote areas, but rather to provide financial assistance towards
maintaining pharmacies in rural and remote areas of Australia. The 6CPA reference above appears to place
more emphasis on improved access, implying that the purpose of the RPMA is intended also as an incentive for
pharmacists to establish pharmacies in rural and remote areas. Both references above do, however, refer to the
intended recipients as pharmacies servicing people in rural and remote regions of Australia. On that note, the
RPMA payment matrix in Table 38 refers to pharmacies PhARIA 2 and PhARIA 3 as accessible, yet they are
eligible for RPMA payments even up to moderate script volumes. It is not clear to what extent the RPMA serves
its purpose as stated in 6CPA of improving access to PBS medicines and pharmacy services to people in rural
and remote regions of Australia. It appears that it would be beneficial to revisit the appropriateness of the RPMA
program and the RPMA payment matrix.
Table 37: Total RPMA payments paid to PhARIA 2 to 6 pharmacies for the 2014-15 and 2015-16 financial years
Source: The Department of Health
Table 38: RPMA payment matrix 2016-17
Source: 6th Community Pharmacy Agreement
Financial Year
Total RPMA
Payments to
pharmacies
2015 13,959,446$
2016 13,452,312$
27,411,758$
133
Appendix 7: Additional information
Average remuneration per script by pharmacy
Figure 28 indicates the average remuneration per script for each pharmacy (each black dot) over the period
2012-13 to 2016-217. Note that pharmacy remuneration is estimated from PBS data and does not reflect trading
terms, discounts, etc. This applies to all findings in this report.
In particular, it indicates that:
over the fifth Community Pharmacy Agreement period (2012-13 to 2014-15), the average remuneration per
script for each pharmacy was around $10 (and ranged from around $7 to $32 per script);
over the fifth Community Pharmacy Agreement period (2012-13 to 2014-15), the average remuneration per
script for each pharmacy was around $10 (and ranged from around $7 to $32 per script);
over the sixth Community Pharmacy Agreement period (2015-16 to 2016-17), the average remuneration per
script has increased to around $11.30 (and ranges from around $8 to $37 per script).
Holding all else equal, this means that if a $10 flat fee was introduced for dispensing, most pharmacies would
lose at least $1.30 per script, with some pharmacies losing up to $27 per script (e.g. specialist pharmacies
dispensing high cost medicines). This raises questions as to whether the $10 flat fee should apply to those
limited numbers of specialist pharmacies.
Figure 28: Average remuneration per script by pharmacy
Source: PBS data
134
High cost medicines
The figures outlined below provide information on the distribution of the high cost medicine sales over PhARIA.
This is intended to provide the Review with some empirical information on the potential impact of a capped ex-
manufacturer’s price. The high cost medicine is defined as medicine with a per pack price above $700.
As illustrated in the figures below, for the vast majority of the pharmacies:
the sales of high cost medicine accounts for around 5% to 10% of the total PBS sales; and
in general, there is no significant difference across PhARIA, with the exception of a few pharmacies
specialised in high cost medicine in PhARIA 1.
As a result, the financial impact of introducing a capped ex-manufacturer’s price is likely to be very small for
most pharmacies other than the few specialised ones.
For example, assuming a medicine cost $1,000, with ex-manufacturer’s price capped at $700, a pharmacy will
need $300 less for holding the inventory or a saving of $15 (assuming an interest rate at 5%). This is equivalent
to 1.5% of the medicine cost ($1000). As high cost medicine accounts for 5% to 10% of the total PBS Sales, the
net impact on profit will be around 0.075% to 0.15%.
Figure 29: Distribution of the value of high cost medicine sales expressed as a proportion of total PBS sales across pharmacies in different PhARIA
Source: PBS data
Notes: See Appendix 5 for outline of methodology used
135
Figure 30: Distribution of proportion of high cost medicine sales across pharmacies in different PhARIA
Source: PBS data
Notes:
1. The PBS sales data extracted from PBS dataset for FY15/16, while the PhARIA data are as at March 2015. As a
consequence, the new and relocated pharmacies in FY15/16 will not have a corresponding PhARIA and are classified
as N/A.
2. Scripts includes broken pack are excluded in the calculation of the total sales of medicine over $700. However, those
are included in the calculation of total pack.
3. Chemotherapy drugs are excluded in the calculation of high cost (>$700) medicine, but included in the calculation of
total.
4. See Appendix 5 for outline of methodology used
136
Electronic prescriptions and dangerous drugs
The two figures below show the distribution of e-Scripts and dangerous drugs respectively as a percentage of
total scripts.
In general:
the up-take for e-script (Figure 31) appears to be:
quite uniformly distributed from 0% to 75% (except the spike at 0%); and
independent of the PhARIA in which the pharmacy is located;
dangerous drugs account for 0% to 8% of the total scripts, with the median around 3% to 4% (Figure 32).
The distribution across all PhARIA appears to be quite similar.
Figure 31: Distribution of e-Scripts as a proportion of total scripts by pharmacies in different PhARIA
Source: PBS data
137
Figure 32: Distribution of percentage of dangerous drug scripts by PhARIA
Source: PBS data
Notes:
1. The PBS sales data extracted from PBS dataset for FY15/16, while the PhARIA data are as at March 2015. As a consequence, the new and relocated pharmacies in FY15/16 will not have a corresponding PhARIA and are classified as N/A and is not show in the graph above.
2. See Appendix 5 for outline of methodology used
138
Trends in dispensing by hospital pharmacies
As indicated in the table below, over the period 2012-13 to 2015-16:
there has been little change in the proportion of total scripts dispensed by hospital pharmacies;
by contrast, the proportion of total PBS revenue paid to hospital pharmacies has almost doubled (from 8.4%
to 16.43%).
This suggests that the cost of medicines dispensed by hospitals is increasing over time (they are dispensing
more expensive medicines each year).
Table 39: Trends in script volumes and PBS revenue for community and hospital pharmacies 2012-13 to 2015-16
Source: PBS data
Additional fees paid to TGA licensed chemotherapy compounding facilities
Table 40: Additional fees paid to TGA licensed chemo compounding facilities
Source: Department of Health data
Community
Pharmacy
Hospital
Pharmacy
Community
Pharmacy
Hospital
Pharmacy
Community
Pharmacy
Hospital
Pharmacy
Community
Pharmacy
Hospital
Pharmacy
2012-13 272,651,887 4,666,891 98.32% 1.68% 10,514,627,073 964,064,058 91.60% 8.40%
2013-14 281,896,725 5,239,335 98.18% 1.82% 10,520,641,901 1,431,369,662 88.02% 11.98%
2014-15 288,820,853 5,511,341 98.13% 1.87% 10,231,074,832 1,592,363,263 86.53% 13.47%
2015-16 292,294,016 5,553,957 98.14% 1.86% 11,561,458,206 2,272,226,301 83.57% 16.43%
Year
Script Count PBS Revenue ($)
Total % Total %
Total Payments Doses Payment per Dose
12,742,800.00$ 637,140 20.00$
CCPS $20 compound fee summary:
TGA licensed facilities
1 July 2015 to 30 June 2016
139
COMMERCIAL IN CONFIDENCE
Appendix 8: Location of pharmacies and the total PBS remuneration they receive
Figure 33: Distribution of pharmacies across regional areas of Sydney and total PBS per pharmacy
Source: PBS data
Notes: The areas shaded in red indicate areas of lower socio economic status and the blue shaded areas indicate areas of
higher socio-economic status.
The yellow vertical bars indicate the total PBS remuneration received by each pharmacy.
Figure 34: Distribution of pharmacies across regional areas of Melbourne and total PBS per pharmacy
Source: PBS data
140
Appendix 9: Wholesale distribution of pharmaceuticals
This appendix presents the key results of the analysis of the effects that current pharmaceutical wholesale
remuneration and regulation have on:
distributional equity – that is, the extent to which current arrangements achieve the government’s objective
of ensuring that:
pharmacies have equitable access to affordable wholesale supplies of the pharmaceuticals they need to
provide Australians with the medicines they need to meet their health needs; and
pharmaceutical wholesalers receive equitable remuneration to compensate them for the efficient costs of
purchasing, storing and distributing pharmaceuticals on behalf of the government;
economic efficiency – that is, the extent to which the current arrangements encourage the:
efficient purchasing and use of pharmaceutical inputs, as well as other inputs, by wholesalers,
pharmacies and Australians (“consumption efficiency”); and
efficient supply of pharmaceuticals, as well as other related inputs, by wholesalers to pharmacies
(“production efficiency”);
fiscal sustainability – that is, the extent to which the current wholesale remuneration arrangements are
sustainable in the medium to longer term.
This analysis has been set out in a separate appendix in view of the commercially sensitive nature of some of
the key financial information provided to the Review on the wholesale distribution of pharmaceuticals.
A9.1 Distributional Equity
A9.1.1 Equity of access of pharmacies to affordable pharmaceuticals
The equity of access that Australians have to the medicines they need to meet their health needs does not just
depend on their proximity to the nearest pharmacy. Rather, it also depends on the equity of access that
pharmacies have to affordable supplies of pharmaceuticals required to supply those medicines to patients.
Currently, there are three main types of pharmaceutical wholesaling in Australia:
short-line wholesaling, which involves the wholesaler purchasing a limited range of products from the
manufacturers and distributing those products to pharmacies (e.g. high volume medicines to metropolitan
pharmacies);
full-line wholesaling, which involves the wholesaler purchasing the full range of products from the
manufacturers and distributing those products to all pharmacies (Community Service Obligation, or CSO,
wholesaling). CSO wholesalers are subject to the CSO Service Standards and CSO Compliance
Requirements which define the minimum services, standards and operating arrangements. The Standards
include a requirement to stock the full range of available PBS items (as defined under the CSO) and to
deliver them to any pharmacy in Australia (except a few very remote locations) generally within 24 hours of
regular order cut-off time. At the moment, there four national CSO wholesalers and one State based
wholesaler:
Sigma Pharmaceuticals Limited (national distributer);
Ebos Group Limited, also known as Symbion Pharmacy Services Pty Ltd (national distributer);
142
A9.1.2 Equity of wholesale remuneration arrangements
In order to ensure that Australians have equitable access to affordable medicines, it is also important to ensure
that the wholesalers that distribute pharmaceuticals to pharmacies also receive sufficient compensation for the
efficient costs of the services they provide on behalf of the government, which include the:
procurement of pharmaceuticals from manufacturers;
storage of those pharmaceuticals; and
distribution of those pharmaceuticals to pharmacies.
What information is available on the efficient costs of pharmaceutical wholesaling?
In order to assess the extent to which the current remuneration arrangements are achieving their intended
objective of compensating pharmaceutical wholesalers for the efficient costs of purchasing, storing and
distributing pharmaceuticals on behalf of the government, it is necessary to have information on the efficient
costs of performing those activities.
Once again, however, there is very little information currently available on efficient costs that pharmaceutical
wholesalers incur in order to purchase, store and distribute pharmaceuticals on behalf of the government. The
remuneration that is currently provided to pharmaceutical wholesalers is not the result of a rigorous process that
is focused on estimating the efficient costs of performing those activities. Rather, that remuneration is more a
reflection of historical precedent, as modified by successive rounds of negotiation between the Pharmacy Guild
and the government.
As a result, most of the information that is currently available to the Review relates to the average revenue and
costs that pharmaceutical wholesalers actually derive and incur from the purchase, storage and distribution of
pharmaceuticals on behalf of the government, as opposed to the efficient marginal costs of preforming those
services. This requires information on the “arms-length” marginal costs of performing those services, not the
average costs that wholesalers currently incur in order to supply those services, or estimates of the long run
marginal costs incurred, on average, by wholesalers.
Table 41 summarises the main sources of financial data currently available to the Review on the wholesaling of
pharmaceuticals in Australia, which include:
Pfizer’s submission to the Review (23 September 2016);
DHL’s submission to the Review, Sustainable distribution of PBS,DHL SUMMARY for Pharmacy
Remuneration review (February 2016);
IBISWorld’s Industry Report F3721 on Pharmaceuticals Wholesaling in Australia (August 2016); and
.
144
It is important to note, however, that:
there are significant practical difficulties associated with estimating the incremental operating and capital
costs incurred by CSO wholesalers (e.g. due to the difficulties associated with allocating costs across CSO
wholesaling and other activities performed by the CSO wholesalers, as well as determining the extent to
which those costs would not have been incurred if they had not performed CSO wholesaling activities on
behalf of the government); and
Although there is little information available on the profits being derived by the wholesaling activities of those
pharmaceutical manufacturers that supply direct to pharmacies, it is reasonable to expect that those profits
would be greater than those derived by CSO wholesalers in view of the:
significant cost savings to be derived from direct marketing of pharmaceuticals to pharmacies.
ability of major pharmaceutical manufacturers to use their significant market power to negotiate more
favourable contracts with pharmacies.
145
Figure 36: Efficiencies gained from direct wholesaling
How equitable are the current pharmaceutical wholesaler remuneration arrangements?
Currently, short-line and direct wholesalers are remunerated at a rate of 7.52 per cent of the ex-manufacturer’s
price of the pharmaceuticals they distribute on behalf of the government (the price negotiated between the
pharmaceutical manufacturers and the government), which is capped at a mark-up of $69.94.
Full-line wholesalers (CSO wholesalers), receive the same remuneration as short-line wholesalers, plus
additional remuneration to cover the additional costs associated with distributing the full range of
pharmaceuticals to all Australian pharmacies and fill orders within 24 hours of regular order cut-off time. This
additional CSO funding, which is currently around per script on average for national distributers, is
determined by:
spreading the annual capped amount of government funding that is available to fund CSO wholesaling
($195.22m) by twelve to determine the total amount of remuneration available each month; and
apportioning this monthly amount of remuneration across each of the CSO wholesalers in accordance with
their unit volume sales for that month (the amount of remuneration received by each CSO wholesaler is
determined in monthly arrears by their share of total sales).
Table 42 illustrates the effects that the current base remuneration arrangements for all wholesalers have on the:
amount of remuneration provided to wholesalers, which increases significantly with the ex-manufacturer’s
price of the medicine; and
nominal rate of assistance that a wholesaler receives from distributing different priced medicines, which
remains at 7.52 per cent of the ex-manufacturer’s price of the medicine up to the point where the mark up
cap of $69.94 is reached, after which it declines as the ex-manufacturer’s price increases.
146
This has the intended effect of providing wholesalers with a level of remuneration that increases with the ex-
manufacturer’s cost of the medicine to compensate them for the higher costs associated with:
financing the purchase and maintenance of sufficient stocks of medicines to meet demand, which requires
higher levels of working capital, the higher the cost of those medicines;
storing medicines, which once again can increase with the cost of those medicines (e.g. due to need for
specialised facilities to store those medicines at a controlled temperature);
replacing spoiled stock, which can also increase with the cost of the medicine (e.g. due to the shorter shelf
life of those medicines);
insuring the stocks of medicines, which also increase with the cost of the stocks stored and distributed;
financing bad debts, which also increase with the cost of medicines supplied.
It is important to note, however, that current wholesaler remuneration arrangements are not based on estimates
of the efficient costs of purchasing, storing, and distributing pharmaceuticals to pharmacies. Rather, like the
remuneration arrangements for pharmacies, they are the result of historical precedent as amended by an
ongoing process of negotiation. As a result, it is inevitable that those remuneration arrangements will over-
remunerate wholesalers for some of the pharmaceuticals they supply and under-remunerates them for others.
For example, the current remuneration arrangements for all wholesalers have the potential to:
over-remunerate those wholesalers that purchase and store either high volumes of low cost medicines, or
low volumes of high cost medicines and distribute those medicines relatively short distances to pharmacies
(it tends to provide relatively high effective rates of assistance to short line wholesalers that supply nearby
pharmacies); and
under-remunerate those wholesalers that purchase, store and distribute to the more remote regions of
Australia. This is, of course, the key reason why a Community Service Order (CSO) funding pool was
created in order to provide wholesalers with additional remuneration to cover the additional costs of
delivering pharmaceuticals to those more remote communities. In particular, under the standard
remuneration arrangements, there is a risk of under-funding those wholesalers that purchase, store and
distribute:
low cost pharmaceuticals in relatively low volumes to the more remote regions of Australia (e.g. full-line
CSO wholesalers); and
high cost medicines to the more remote regions of Australia (e.g. full-line CSO wholesalers). For
example, as illustrated in Figure 37, the NPSA submission to the Review argues that under the current
funding arrangements, CSO wholesalers are distributing high cost medicines with a price in excess of
$5,000 at a loss (they argue that the current cap of $69.94 is insufficient to cover the costs that full-line
wholesalers have to incur in order to distribute high cost medicines costing more than $5,000).
147
Table 42: Illustration of how the current wholesaler remuneration arrangements affect the nominal rates of assistance provided to the wholesale distribution of medicines with different prices
Source: Review Team
Notes:
1. Wholesaler remuneration is an estimate because trading terms etc. between pharmacies and wholesalers are largely unknown.
Figure 37: Full line wholesaler costs for distributing high cost drugs
MedicineEx manufacturer's
price
Remuneration
to wholesaler
Nominal rate
of assistance
to wholesaler
Medicine 1 $10 $0.752 7.5%
Medicine 2 $30 $2.256 7.5%
Medicine 3 $70 $5.264 7.5%
Medicine 4 $100 $7.520 7.5%
Medicine 5 $400 $30.080 7.5%
Medicine 6 $930 $69.936 7.5%
Medicine 7 $1,000 $69.936 7.0%
Medicine 8 $1,500 $69.936 4.7%
Medicine 9 $2,000 $69.936 3.5%
148
A9.2 Economic Efficiency
A9.2.1 Consumption efficiency
In addition to improving the equity of access of Australians to affordable medicines and equitably compensating
wholesalers for the purchase, storage and distribution of pharmaceuticals, it is also important to reduce any
unintended adverse effects that the remuneration arrangements for wholesalers have on the economic efficiency
with which pharmaceuticals are purchased and used by wholesalers, pharmacies and by Australians.
The current remuneration arrangements provide a significant level of financial assistance to the wholesalers that
supply the pharmaceuticals that pharmacies dispense. This has the intended effect of significantly increasing
both the quantity and range of pharmaceuticals supplied to pharmacies and the individuals who purchase their
medicines from those pharmacies.
In addition, as indicated in Table 42, the current remuneration arrangements also provide wholesalers with the
same nominal rate of assistance for supplying pharmaceuticals that have ex-manufacturer’s prices of up to
$930. This means that if all wholesalers incurred the same costs, these remuneration arrangements would not
unintentionally distort the decisions that wholesalers make regarding the types and quantities of pharmaceuticals
to purchase and store, or the pharmacies to supply.
As discussed further in section A6.2.2, however, since wholesalers incur different costs, this potentially has the
unintended effect of providing the highest effective rates of assistance to those wholesalers that purchase
relatively high cost medicines to supply to nearby pharmacies.
In addition, although the $69.94 cap that is imposed on the level of remuneration provided to all wholesalers
might reduce fiscal costs and reduce the extent to which the remuneration arrangements potentially
unintentionally encourage wholesalers to supply higher cost pharmaceuticals to nearby pharmacies, it can also
have the unintended effect of discouraging short line wholesalers from purchasing, storing and supplying high
cost medicines with ex-manufacturer’s prices in excess of $930 since wholesalers receive lower nominal rates of
assistance for distributing those pharmaceuticals.
A9.2.1 Production efficiency
As noted in section A6.2, however, since the current remuneration arrangements for all pharmacies wholesalers
are not based on estimates of the efficient costs of purchasing, storing and distributing pharmaceuticals to
pharmacies, it is inevitable that those arrangements will over-fund the supply some wholesalers for some of the
pharmaceuticals they supply, and under-fund others.
These potentially unintended effects not only reduce the equity with which wholesalers are remunerated, but
also potentially distort the decisions of wholesalers regarding the:
types and quantities of pharmaceuticals to purchase and store;
as well as the location of pharmacies to supply.
In particular, the current remuneration arrangements for all wholesalers have the potentially unintended effects
of providing the highest effective rates of assistance for those wholesalers that:
purchase and store pharmaceuticals with an ex-manufacturer’s price of less than $930; and
distribute those pharmaceuticals to nearby pharmacies.
149
This is one of the reasons why the wholesale mark up has been reduced in the past and a separate CSO
funding pool was introduced.
In the first, second and third Community Pharmacy Agreements (CPAs), wholesalers received a markup or 11.1
per cent on the cost of the pharmaceutical and there was no obligation to supply pharmaceuticals to the more
remote regions of Australia.
This had the unintended effect of providing the highest effective rates of assistance to those wholesalers who
distributed the highest values of pharmaceuticals (e.g. high volumes of low value pharmaceuticals, or low
volumes of very high cost pharmaceuticals) the shortest distances, which encouraged the growth in market
share of short-line wholesalers.
In an effort to reduce those unintended adverse effects on both the equity of access of Australians to affordable
medicines and the economic efficiency of pharmacy wholesaling, the fourth CPA:
reduced the wholesale mark up from 11.1 per cent to 7.52 per cent;
placed a ceiling on the mark up of $69.94; and
created a Community Service Order (CSO) funding pool to fund the additional costs associated with
supplying a full range of pharmaceuticals within 24 hours to all areas of Australia, particularly the more
remote regions.
A9.3 Fiscal Sustainability
The main instruments that the government has at its disposal to control the fiscal costs of the current
remuneration arrangements for pharmaceutical wholesalers include the:
“price conditional subsidy” negotiations that occur between the government and pharmaceutical
manufacturers that set the maximum prices that manufacturers agree to charge in return for listing of the
pharmaceuticals they supply, which results in the subsidisation of the prices that wholesalers, pharmacies
and patients have to pay for those pharmaceuticals. Although those negotiations are beyond the scope of
the Review, it is important to note that their outcome has important implications for both the fiscal and
economic costs of the current pharmaceutical wholesale remuneration arrangements since the amount of
remuneration paid to wholesalers is a percentage of the ex-manufacturer’s price of those pharmaceuticals;
price disclosure arrangements that require pharmaceutical manufacturers to disclose the prices that they
charge for the pharmaceuticals they supply that are listed on the PBS. This constrains the extent to which
those manufacturers can charge the government higher prices for pharmaceuticals than they charge
wholesalers and pharmacies for those pharmaceuticals (it reduces the extent to which manufacturers are
able to “discount” the prices of the pharmaceuticals they supply). Estimates of the fiscal savings from those
price disclosure arrangements are set out in Figure 38.
151
Appendix 10: Glossary
Term Definition
Co-payment Refers to the upper limit of the price to a patient for a script for a patient
category ($38.80 for general patients or $6.30 for concessional patients)
Deadweight Cost The harm caused to economic efficiency and production by taxation.
Dispensed price Commonwealth dispensed price for maximum quantity (DPMQ). If
quantities other than maximum quantity are dispensed it refers to the
DPMQ of the script adjusted for quantity differences.
Distributional Equity The extent to which the current arrangements, and any proposed changes
to those arrangements, achieve the government’s objective of ensuring
that:
Australians have equitable access to affordable medicines,
regardless of their location and wealth; and
pharmacies receive equitable remuneration to compensate them
for the efficient costs of supplying medicines on behalf of the
government.
Economic Efficiency The extent to which current arrangements and any proposed changes to
those arrangements encourage the:
efficient use of medicines as well as other goods and services
(consumption efficiency); and
efficient supply of medicines, as well as other related goods and
services and the efficient use of resources by those activities
(production efficiency).
Economic rents “Monopoly” or “super normal” profits and rates of return that exceed normal
rates of return
Effective rate of
assistance
The change in value added before and after government assistance (e.g.
subsidy), expressed as a proportion of value added before government
assistance
Generalised cost In transport economics, the generalised cost is the sum of monetary and
non-monetary costs of a journey.
Nominal Rate of
assistance
The percentage by which government policies have raised or lowered gross
revenue or costs above what they would be without the government's
intervention
Value added Returns to factors of production (land, labour, capital and enterprise) the
difference between the total sales revenue and the total cost of materials,
and services purchased from other firms. The use of high and low value
adding activities in the report refers to its meaning in an economic context
rather than a health outcome context.
Assisted value
added (AVA)
AVA is equal to the value of outputs less the value of inputs in the presence
of government subsidy
Unassisted value
added (UVA)
UVA is equal to the value of outputs less the value of inputs in the absence
of government subsidy