Having your prescription filled with a cheap generic drug rather than a more expensive brand is supposed to be good for your wallet (they're cheaper) and good for the nation (by lowering the overall cost of healthcare). But CVS, Walgreens (WAG), Kmart, Kroger (KR) and Target (TGT) have found a way to line their own pockets in the process, according to a lawsuit filed by the attorney general of West Virginia.
Almost all states have laws encouraging generic substitution at the pharmacy. If your doctor prescribes the cholesterol drug Zocor, for instance, your pharmacist is supposed to ask you if it's OK to fill the scrip with generic simvastatin. It's the same drug, and the white coat behind the counter is supposed to tell you how much money you'll save by doing so.
West Virginia took its law a step further, and required pharmacies to pass on to patients the savings they make by going generic.
But West Virginia attorney general Darrell McGraw noticed that in the annual reports of CVS and Walgreens, the companies claimed they actually made more profit when they sold generics than when they sold brands. CVS's 2007 annual report says (see page 8):
Although their lower prices depress revenue growth and we continue to see pressure on pharmacy reimbursement rates, generics are more profitable than brand name drugs and help drive margin expansion.Walgreens made a similar claim in its 2008 annual report:
In addition, we continued to benefit from the increased utilization of generic drugs (which normally yield a higher gross profit rate than equivalent brand name drugs) in both the Retail Pharmacy and Pharmacy Services segments.
Overall margins were ... partially offset by an improvement in retail pharmacy margins, which were positively influenced by generic drug sales, ... Retail pharmacy margins increased as a result of growth in generic drug sales.Savings not passed on
Under West Virginia's law, pharmacies can't possibly make more money on generics than brands because the savings are supposed to be passed to the consumer. The West Virginia suit gives this hypothetical example:
- Branded drug
Pharmacy's acquisition cost: $64.76
Pharmacy's price to consumer: $96.09
- Generic drug
Pharmacy's acquisition cost: $7.20
Pharmacy's price to consumer: $56.59
- Pharmacy's price to consumer had the pharmacy been following the law: $38.53 (i.e. $31.33 plus $7.20).
CVS et al. claim the suit should be thrown out because it doesn't contain a specific concrete example of this ever happening; West Virginia recently won federal appeals court ruling allowing the case to proceed, which may produce those records in discovery.
In states other than Virginia, making larger profits on cheaper drugs and failing to pass on the savings is completely legal. In theory, those profits ought not to occur because pharmacies should be competing on price. If a store can acquire a pill for as little as $7.20, prices ought to fall quickly toward that level in a race to the bottom. But, as the Wall Street Journal discovered in 2007, prices don't fall that far.
Why might that be? It's interesting that both CVS and Walgreens noted in their annual reports that the source of their gross margin increases were generic drugs. This was not a mandatory disclosure. A conspiracy theorist might suggest that this is an example of "signalling"; the practice of drawing your competitor's attention to the fact that if you both refrain from getting into a price war you can both keep prices and margins high.
This is perfectly legal as long as neither company overtly cooperates with the other. That, surely, can't be the explanation for the amazing coincidence of both companies making higher profits on cheaper drugs. Can it?
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