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Generic-drug markups top brand names

Little noticed in the furor over high prescription-drug prices is a startling fact: Patients, particularly those without insurance coverage, are paying high retail prices for supposedly cheap generic versions of popular drugs.

Generic drugs still are priced significantly lower than their branded counterparts, but they are often much more profitable for pharmacies. Drugstores are marking up the price of some generics by more than 1,000 percent _ pocketing, say, $34 for ulcer-drug pills that can cost a store less than $3.

That fat retail margins on generic drugs have survived today's intensely cost-conscious health care environment is surprising, but a complex interplay of competitive market forces and health policy has preserved this pocket of profitability for pharmacies.

Ultimately, those least able to pay for prescription drugs are most burdened by the markups: patients who don't have health insurance and the elderly on Medicare and without prescription-drug coverage. Those patients actually are being hit twice _ they pay for prescriptions out of pocket, and they often pay the highest prices. Managed care firms sometimes negotiate much better deals on generic medicines, but uninsured customers, who buy 25 percent of all prescription medicines, lack the clout volume-buying insurers wield.

Much of a generic drug's discount to its branded counterpart "evaporates by the time the product goes through wholesale and retail channels," says Steven Gerber, an analyst with CIBC Oppenheimer & Co. In fact, he says, "Generics have served in many cases to be a profit boon to drug wholesalers and retailers."

Markups on some generics are extraordinarily high, as revealed by a comparison of one large manufacturer's charges with average retail prices compiled by market researcher PMSI Scott-Levin. For example, stores charge an average of $18.08 for a prescription of the generic version of the antipsychotic drug Haldol, 2,800 percent more than the 62-cent cost the generic manufacturer charges. A prescription for the generic of Zovirax, an antiviral drug, sells at pharmacies for an average of $61.64, more than eight times the manufacturer's price of $7.22. A prescription for the generic of the antianxiety pill Xanax sells for $15.56, which pharmacies and wholesalers can buy from the manufacturer for about 78 cents. Markups on branded drugs, by comparison, generally range from 10 percent to 30 percent.

Retail prices vary from store to store; and they vary from customer to customer because health plans and the government negotiate different, often lower prices. But, overall, generic drugs are critical to a pharmacy's profitability. "Without the generic drugs, most pharmacies would be in deep trouble," says Hemant Shah, an independent industry analyst in Warren, N.J. "That's why pharmacists aggressively push generic drugs."

Generic-drug pricing practices are expected to receive more attention as a result of a recent controversy over sharp price increases by the biggest independent U.S. generic drugmaker, Mylan Laboratories of Pittsburgh. Mylan recently drew federal charges of trying to corner the raw-materials market for two tranquilizers, including the generic of Ativan, to enable it to sharply raise its prices. Based on an internal Mylan pricing document obtained by the Wall Street Journal, and on data from Scott-Levin, the manufacturer's prices paid by wholesalers and retailers are a tiny fraction of the average retail prices of Mylan products paid by pharmacy customers. Prices of other generic drugmakers may vary somewhat from Mylan's but are usually competitive.

Mylan denies the government's charges, says a company spokeswoman. She declined to comment on pharmacy pricing practices.

At the manufacturer's level, prescription drugs can be enormously profitable for makers of both branded and generic drugs. Although gross profit margins vary widely, branded pills can have a margin of 90 percent or higher at the manufacturer's level, while generics can have gross margins of 40 percent, analysts say.

But the generics can be even more profitable at the retail level. Pharmacies reap most of the difference between the manufacturer's price and what the customer pays. (Many large retailers buy drugs directly from manufacturers; retailers that use wholesalers pay an additional 5 percent to 20 percent over the manufacturer's price.) Those generous margins help to offset the shrinking profits from branded drugs, as managed care companies focus their greatest cost-cutting efforts on big-ticket pharmaceutical products.

Cost-conscious health plans know about the big margins on generic drugs, but they want pharmacists to push generic drugs because they are much cheaper than branded drugs. A prescription for the generic version of Capoten 50-milligram, at an average of $41.80, is a bargain compared with the $115.62 average retail price for the branded version. A health plan saves $73.82 if a pharmacy fills a prescription with a generic version. "That's still the greater gain (for health plans) than trying to eat into generic distribution margin," Gerber says.

Health plans also know that doctors are influenced by sales calls and advertisements promoting expensive branded drugs, while there is little, if any, promotion of generic alternatives by drugmakers. Health plans view the pharmacist as a critical player who can counterbalance branded companies' marketing influence on doctors by filling a prescription with a cheaper generic drug rather than its branded version. But the right financial incentives for the pharmacist have to be in place.

In the case of generic Capoten, pharmacies have a big incentive: Pharmacies can make $39 in gross profit for a generic Capoten prescription paid for by a cash customer, compared with the $11 they make filling it with the branded drug. So the pharmacist looks like a good guy when he encourages a customer or doctor to use a generic to save money, and he makes a bigger profit. The health plan patient is usually oblivious to the pricing complexities because he or she makes the same co-payment, usually ranging from $5 to $10, regardless of the prescription's cost.

Pharmacies argue that focusing on generic drugs' high gross margins doesn't tell the whole story. "You aren't just buying and reselling a product at a certain markup," because drugstores are burdened with hefty retail costs, including the pharmacist's professional services, says Kurt Proctor, senior vice president of pharmacy policy and operations at the National Association of Chain Drug Stores. Just as a patient who visits a doctor and gets handed a Band-Aid isn't billed for just the Band-Aid, a pharmacy customer has to pay for the pharmacists' time and other overhead expenses. And regardless of whether a prescription is filled by a generic or a brand, those basic costs are the same, averaging about $6 a prescription, according to the association.

Pharmacy experts also argue that the mathematics of markups are misleading. For example, a 2,700 percent markup sounds extraordinary, but, in absolute dollars, the difference is relatively small: for a pill that costs the pharmacy a penny, the marked-up price would be 28 cents, but a similar 27-cent increase on a $1-a-pill branded drug would be only a 27 percent markup. Including branded and generic drugs, pharmacies on average have a 24 percent gross margin, and an average net margin of 2 percent, after all the costs are deducted, Proctor says.

And, pharmacies note, many health plans are trying to squeeze some of the profit out of their generic-drug bills by negotiating lower prices.

But health plans generally still try to make sure the profit margin is equal to, or higher than, what the pharmacist would get for a brand, in order to maximize the use of generics.

"There's no doubt that there's a bigger margin on generics than brands," Proctor says. "The pharmacy will do better on generics, and the consumer will do better. . . . Clearly it's set up to be a win-win for everybody."