Pharmacy is poised for a rebound, thanks to cost-based reimbursement.
That is the message of a report by McKinsey and Co., which says retail pharmacies may be able to overcome financial challenges with new remuneration models.
Titled “The revival of pharmacy: The rise of cost-based reimbursement,” the report says that despite pharmacies being “a critical health care resource,” the fiscal challenges have led to bankruptcies like Rite Aid’s, as well as store closures across the industry.
“Legacy drug-pricing models have been one area where retailers have struggled,” it says. “These models have not been able to adapt to shifting drug mixes, and as a result, gross margins from pharmacies have declined.”
This has had a major effect on the drug store business, because most stores generate 80% of their revenue from pharmacy, and just 20% from the front end.
“Today, retail pharmacies rethinking their pricing structures are exploring a new alternative: cost-based reimbursement models,” the report says. “These models could better align the prices of prescriptions with underlying input costs and the services that pharmacies provide.”
They could also increase transparency, bringing much-needed simplicity to a complex system. By helping retail pharmacies face financial challenges and avoid further closures, these models could allow patients to keep accessing care from these vital sources of care.
Retail pharmacy is at an inflection point. It is central to U.S. health care, with total prescription drug sales reaching $683 billion in 2024. Retail pharmacies play an especially large role, getting 13 billion visits per year nationwide, or an average of about 270 million patient visits per week.
Notwithstanding its role in health care, “the retail pharmacy ecosystem has been marked by immense change and challenges in recent years,” says the report. The traditional drug dispensing market has experienced more gross margin compression than many other segments of the health care industry, the result of declining reimbursement and increasing operating costs, including rising labor costs driven by ongoing pharmacist labor shortages. Simultaneously, many retail pharmacies are locked into long-term leases for prime real estate.
In the face of these headwinds, some 9,000 prescription counters have closed since 2017 across all trade classes, including chain stores, independents, supermarkets and mass merchants.
Neither traditional techniques (such as boosting labor force productivity) nor newer means (like automation and innovation) seem to be sufficient by themselves to address the challenges.
But there may still be a way to revive the pharmacy industry by rethinking conventional pricing models. Some pharmacies have already begun exploring new cost-based reimbursement approaches. Instead of tying reimbursements to average wholesale price, these models calculate remuneration based on how much it costs a pharmacy to acquire a drug (COGS), plus additional fees and markups to cover costs such as pharmacist counseling, dispensing and shipping.
“By tying costs to COGS, not the average wholesale price, cost-based reimbursement means retailers do not need to rely on cross-subsidization of branded and generic drugs,” says the report. “It also creates a more transparent, consistent and predictable margin earned per prescription dispensed, with opportunities down the road to match benefit coverage to respective prescriptions.”
Cost-based reimbursement alone does not necessarily lift or depress margins, but it can improve margin composition in a couple of ways. First, lessening cross-subsidization can create more predictable margins. Second, this enhanced visibility into cost can lead to clearer, more productive conversations with PBMs.
“Cost-based reimbursement models are showing early traction among major PBMs, and they could bring the pharmacy value chain up to speed with today’s shifting needs,” asserts the report.
Questions remain, but “cost-based reimbursement shows promise, though it may affect each of the critical players across the pharmacy value chain differently.”
