Automobile Leasing, Printer Ink, and Peloton Offer Look at Pharmacy’s Future
We have been saying a services model is the solution for 3 decades; now it is time to live it.
"Manufacturing is a tough business model in the 21st century,” I remember the CEO of a well-known pharmacy dispensing system telling me a few years ago. He lamented that a business can manufacture a high-quality product with happy customers, but if no part of the gross receipts is “consumable,” there is no opportunity for growth and sustainability of production and sales. There are 2 choices for the manufacturer: design the product to be obsolete in a few years (see iPhone class-action suit after the company admitted purposely slowing down the operating system in old phones) or design the product to break down in the same short period of time (see modern appliances).
Car Manufacturers Love Lessors for a Reason
The diminishing returns problem is not lost on car manufacturers. Although the number of licensed drivers in the United States is large at more than 220 million, the number of younger drivers is shrinking, from roughly half of teens licensed in the 1980s to less than a quarter of teens with a license now.1 Car manufacturers are constantly looking for ways to sell new vehicles despite dropping consumer need for new automobiles. Automobile manufacturers produce vehicles that can easily average more than 300,000 miles on the road. So how do they get new car buyers back to the sales lot?
Leasing became a popular way to get a car without owning it. Leasing allows the user the affordability and freedom of a subscription model of
financing without the commitment to buy. Leasing has become more popular, even in the face of very low financing, with growth expected at about 10%
annually over the next decade.2 This is good news for carmakers, as most lessees choose to roll over their lease to a new car, especially as millennials increasingly
prefer rented models over ownership models (see same trend in real estate).
The Printer Ink Model
MBAs have been busy in front of whiteboards for a while trying to solve the diminishing returns problem in the ink printer market space, which they did for a while. Most people do not know that printer ink, when purchased through those throwaway cartridges, is extremely expensive. Hundreds of millions of ink cartridges are sold each year to customers who locked themselves into a cheap purchase with extremely high ink maintenance costs. Printer ink manufacturers lose money producing the printer and make a generous margin forcing the buyer to purchase ink at a premium. This strategy emphasizes the profitability in the “consumable,” not the “durable,” good. Frustrated with paying increasingly more money for decreasing amounts of ink, I recently bought an inkjet printer with a “super tank” that contains enough ink to last for 2 years with regular use. If I use this printer for 5 years, I will save more than $1000 in the total cost. But for manufacturers, it is a gamble, because they have largely eliminated the “consumable” aspect of the product.
Direct Primary Care and Medication Dispensing Follow
Similarly, our brothers and sisters in primary care struggle with some of the same market and service purchasing dynamics. Frustrated by the high cost and low return effort of insurance contracting, claims submission, rejection, and low payment, the “direct primary care” movement grows stronger each day.
The premise? Move to a subscription fee model and away from a fee-for-service model, wherein a basic set of primary care and laboratory services are provided without a per-visit or service cost but rather come as a $60 to $120 per-month fee, depending on the size of the family. Consumers like the access, budget predictability, and more affordable cost than showing up to the health system and having no clue how many hundreds of dollars the bill will be. Similarly, providers like the direct relationship, dramatic reduction in administrative overhead, and predictable revenue.
The missing piece? Medications. Many direct primary care providers are supplying patients with large supplies of maintenance medications for “free” under the subscription model. Some even provide a year’s supply (think inkjet printer super tank) of medications for common conditions, such as diabetes and hypertension, treated by “penny drugs.”
Direct Primary Care and Peloton Show the Way
SoulCycle is a high-end exercise class business that based itself on the notion of high quality but fee-for-service pricing and revenue models, which have struggled lately. Peloton, however, is bursting at the seams. Yes, the “do-itat-home” model helps during a pandemic (see telemedicine growth), but Peloton’s success and future success are much more than that. The company plans on a future where it
knows it will not be profitable to manufacture products. It never even bothered with fee-for-service, following subscription models akin to office equipment (copiers) and contact lenses (moving to unlimited supply for periods of time rather than units).
Peloton’s model of hardware-to-service produces 80% of its revenue from manufacturing and 20% from subscription services.3 That will likely change dramatically over time as subscribers continue to grow from about 1.4 million as of June 2020 and will eventually be subject to additional manufacturing competition from other bikes, as well as a slower-growing, perhaps contracting number of total users who even want a bike. Importantly, hardware sales could fall dramatically and profits could rise simultaneously.
Herein lies the most important lesson for pharmacies: Services-based revenue models tend to have gross margins of 40% to 60%, whereas product-based models tend to have gross margins of 5% to 20%. The future of pharmacy is not gross sales and margins on those product sales. The future is in the recurring services margin, which is predictable and scalable, with low overhead and aligned with the patient’s needs. Example: fighting with oneself on a 30- versus 90-day supply? It does not matter if the consumer has purchased a subscription model.
Drug Spending Trends Scream for Subscription Models
Two percent of all prescription fills in 2020 were 50% of the total drug spending. Another 8% of brand dispensing rounded out another 30% of the cost. That means that 90% of the fills made up 20% of the total cost, and about 300 medications that treat most chronic diseases in the United States are cheaper than a pound of sugar for a year’s supply.
‘Patients Will Not Pay for It’ Thinking Is So 20th Century
Pharmacists, like many others, are subject to Stockholm syndrome. Corporate executives and small-business owners alike have come to believe that third-party coverage is essential for consumer interest. Yet I have been a Blue Cross Blue Shield member for more than a decade and I cannot recall a single time that I used the prescription coverage card for my family of 5 with my high-deductible plan. When I hear pharmacists say, “The patient will not pay for a service or a subscription,” I think, they already pay more than full price when they use their “insurance” cards. GoodRx and the proliferation of many equivalent discount cards validate this. Only a minority of Americans financially benefit from their prescription drug coverage, particularly for those with employer “coverage.”
Pharmacy Services Are Accessible, Affordable, Trusted
Pharmacy will do well when on the same playing field with other health care providers. We keep farming the dying fields (product and retail), and the new fields (services and subscriptions) are looking for accessibility, affordability, and trust. Pharmacy truly is the “front door to the health care system and its services” and has been operating on a business model at cross-purposes.
Health Care Services as Subscriptions Are the Future
Which is more sustainable? $5 million in gross revenue producing a 2% profit margin or $2 million in gross revenue producing a 20% to 40% profit margin? Losing the local employer’s plan to a narrow network or losing a patient or 2 leaving town? Medical providers have built business models on panels of patients and now subscription services to match. How much more sustainable is pharmacy with
a monthly or quarterly “consumable” of service, including dispensing, with a biometric check-in, immunization review, screening, and other services that can be successfully delivered only locally? On a per-pharmacist basis, a panel of 2000 patients (500 families) that produces $10 per month in gross margins is sustainable, even profitable, similar to primary care.
By the way, SoulCycle now has an at-home subscription model that works as a side-by-side to its local studios post-COVID-19 vaccination. If you can’t beat ’em, join ’em.
TROY TRYGSTAD, PHARMD, PHD, MBA, is the vice president of pharmacy programs for Community Care of North Carolina, which works collaboratively with more than 1800 medical practices to serve over 1.6 million Medicaid, Medicare, commercially insured, and uninsured patients. He received his PharmD and MBA from Drake University in Des Moines, Iowa, and his PhD in pharmaceutical outcomes and policy from the University of North Carolina at Chapel Hill. He also serves on the board of directors for the American Pharmacists Association Foundation and the Pharmacy Quality Alliance.