Pharmacy franchises: Still alluring or losing their luster?

April 1, 2002

Some franchisees complain about high royalty fees

 

SPECIAL REPORT

Pharmacy franchises: Still alluring or losing their luster?

While joining the ranks of leading companies such as St. Louis, Mo.-based Medicine Shoppe International (MSI) or Des Moines-based Medicap Pharmacies can offer myriad benefits, from providing financing to finding a location, there's growing evidence that the franchise concept is losing some of its luster. Topping a long list of complaints leveled by franchisees at these companies are high royalty or license fees, few real price breaks from wholesalers, lack of relevant marketing support, and poor third-party contract negotiations.

Slow expansion by major players, not to mention the withdrawal of several smaller franchise brands from the market over the past few years, is one indication of cracks in the system. After experiencing strong growth in the mid-1980s, MSI today counts 1,100 stores in the United States and another 250 in its international operations. Medicap has 184 stores open today with another 15 in development. Minnetonka, Minn.-based Snyders/Drug Emporium has a franchise network of 65 stores under its banner and another 16 licensed outlets that resulted from the buyout of Drug Emporium last October. Arlington, Va.-based Care Pharmacies was recently restructured from a buying group into a 44-store franchise company.

For some franchisees these numbers aren't heartening. Mike Martin admits that a desire to be, in his words, "part of something big" was the motivation behind striking a deal with Medicine Shoppe to open a store in Dallas, Ga., in 1991. When he joined, said Martin, the company had introduced a program called "2000 by 2000," implying it would have 2,000 stores by the end of the century. "At that time, the largest national chain was only about 1,000 stores, so my thinking was that this company was going places and I needed to get on board," he explained.

Bill Tatum, an MSI owner in Suffolk, Va., since 1987, was also swept up in the franchising tide during a period of rapid growth. "They were expanding at a rate of about 150 stores a year, and they were talking big about launching national advertising and other programs," said Tatum, who was then working for the People's drugstore chain.

If Martin, Tatum, and others once thought they were riding the wave of the future, they're not so sure today. The company has failed to come close to targeted expansion, they said. And there's also some evidence that the number of individual franchises is actually decreasing, with the only growth recently coming from an increase in the number of corporately owned stores. Martin also questions MSI's record of convincing franchisees to renew their contracts for another 20 years.

MSI's president and CEO, Marc Parrish, who moved over from parent company Cardinal Health last June, concedes there's been only a "mild increase" in the number of stores recently. While he declined to disclose figures on annual unit growth over the past few years, he projected the addition of 25 new stores this year, a number of which will be owned by existing franchisees bent on expanding their holdings. He stressed, too, that MSI is on track in terms of contract renewals. "We're not 100%, but we're meeting our objectives," he said, noting that the company doesn't release these numbers.

Medicap, which has branched out to 36 states in the 21 years since its inception, is in line with growth of about 15 to 25 stores a year, said Rick Swalwell, v.p. of marketing and communications. While he also declined to give out numbers, he said that the majority of members renewed. "That's not to say that people don't get out of the system for a variety of reasons," he added.

Price is not right

Things have slowed down since the halcyon days of the 1980s, when franchise companies—largely the successors to the buying groups formed by the coalescence of independents in the '60s to qualify for volume discounts from wholesalers—were experiencing their strongest growth. The slowdown is largely due to their inability to accept today's economic realities, explained Doug Hardin, owner of a Medicine Shoppe franchise in Foley, Ala.

"They continue to refuse to address the issue of high license fees, and yet we've been forced to change the way we do business because of increasing prices, declining reimbursements, and a proliferation of discount cards," Hardin said.

Indeed license fees—or monthly royalties that at MSI can vary from 5.5% of sales for new stores, to 3% for stores that renew contracts after 20 years, and 2% for independent pharmacies that have converted to the system—are undoubtedly the most contentious issue for franchisees. On top of this is an up-front origination fee, which is $18,000 at MSI. Special deals for franchisees that renew before their 20 years' licenses expire have been used as incentives over the past couple of years.

Medicap offers a similar type of fee structure, consisting of a $15,000 price tag for new stores and $8,000 for a conversion from an independent store. Recently, under some pressure about its payment structure, Medicap cut its license fees, which pay for support systems such as accounting, procurement, and professional pharmacy services, from 4% to 3.9%. The addition of a 1% marketing fee brings the total royalty bill up to 4.9%. There is also some built-in flexibility in the marketing budget that reduces the payments from some stores.

"These companies are using a business model developed 30 to 35 years ago, at a time when average pharmacy gross profits were 35% to 40%," charged Martin. Given that today's average gross profit has slipped to 21%, taking 5% off the top results in pharmacists "just paying bills," he added. For newer licensees just starting out, this is even more difficult. Indeed, some franchisees say that a search of MSI's store database shows that a high percentage of pharmacies that opened in the past four or five years are no longer in business.

Even veteran pharmacists like Tatum, who paid off his loan at a time when margins were higher and has only three years left on his MSI contract, complain that they're being squeezed by license fees, while MSI focuses on maximizing its profits. In fact, like other franchisees, Tatum admitted to declining to fill some higher priced prescriptions because he can't break even on the sale. "If I pay $100 for a drug for which I'm reimbursed $103 by the insurance carrier and then turn around and hand $5 over to MSI, then I'm in the hole," he said, noting that years ago when he was operating at 35% gross profit, he could afford to give up 5%.

MSI's Parrish countered that within any franchise organization, license fees are a "very emotional" issue and that there will always be those who believe the percentage is too high. Franchisees tend to ignore the many values being delivered by MSI for its fees, said Parrish. Along with strong representation to the third-party networks, strong buying programs as well as financial, real estate, and other services that "touch all the issues for running a successful pharmacy," he said the company had made a dramatic investment into the pharmacy services group trying to create programs that lead its pharmacists toward more profitable areas of pharmacy.

While there's a consensus in the industry that "franchisees just don't like to pay license fees," Medicap is not blind to the challenges posed by the proliferation of expensive drugs on the market, not to mention the penny-pinching policies of managed care companies, explained Swalwell. The company's decision to cut license fees last June was a response to members' complaints that after paying royalties on high-end products, they were actually losing money.

Originally, Medicap members had suggested the application of a "sliding scale" that would see their license fees reduced on higher-cost drugs, but the company chose the blanket reduction of 0.1% to avoid what Swalwell described as a "logistical nightmare." And while members may not make money on every prescription filled, they make up for this in their high volume of prescriptions filled, many of which have good profit margins, he added. He also noted that net earnings are outpacing shrink in margins because of sales increases. "Our franchisees are undoubtedly making more money," said Swalwell, adding that for 18 of the past 22 years, sales increases have topped 20%.

Steve Amato, who two years ago took over a 2,400-sq. ft. location that had been converted from an independent to an MSI franchise in Dunedin, Fla., is a strong supporter of his franchise. "Yes, they're taking a lot of money out of my pocket, but they're putting a lot back in," he said, adding that he is shopping around for a second location.

A former employee pharmacist for a chain as well as giant discounter Wal-Mart, Amato said that not only is he much happier running his own show, but today he's making far more money—at least twice what he was earning before. And the brand, he said, is a strong draw for many of his customers who are familiar with the name up north. Of course, he admitted that his 2% royalty fee gives him some advantage over those paying 5.5%.

True value in services

Medicap franchisee Patsy Keating of Batesville, Miss., quipped that those who complain about license fees have at least one option—they can make less money from the business and pay less back. "I don't understand why they sign a contract that spells out all the terms clearly, and then five years later they start grumbling about paying fees," she said.

Keating believes pharmacists tend to forget the massive efforts of franchise companies, especially at start-up time. "When I opened my store, I sat down and watched as others stocked the shelves with merchandise and made the phone calls to suppliers," she said, adding that there is a true value to these services that she is continuing to pay for today.

Many franchisees, Keating observed, don't take advantage of what's available through their franchise company, such as advertising and marketing programs, which she credited with boosting her business significantly over the years. Indeed, both Medicine Shoppe and Medicap offer numerous programs to help with operations and marketing. Medicap has a private "Intranet," which allows franchisees to connect with corporate offices and access real-time information on operations, including best practices.

Steve Mowery, a Medicap franchisee in Clarinda, Iowa, agreed that while "no one likes to write a check every month," he nonetheless thinks he made one of the wisest choices in his business life when he signed on in 1986. Indeed, he said that his expectations have been more than met.

But some franchisees who've handed over higher fees for many years aren't as convinced that the franchise companies are holding up their end. "There are a lot of empty promises made at the beginning when they say they're going to do this or that for you, and then it turns out that everything falls on you," said Mike Wilusz, who opened his Adams, Mass., franchise in 1979 after working for an independent pharmacy. If he was drawn to advertising programs, he said he was soon told that local advertising was his responsibility.

And Rupert Jung, who opened his Medicine Shoppe franchise in Red Bluff, Calif., in 1984 after working as a hospital pharmacist, said he was initially drawn to the group's programs. Back then, he said, the company did deliver, especially in providing experts to help him with operations and marketing issues. Like others, though, Jung maintained that the fee "hasn't kept up" with the programs. "The royalty is rock solid, and yet they haven't been able to deliver opportunities for us to improve our gross profits, which have been shrinking over the past 15 years," he said.

While the majority of MSI franchisees—most of whom draw over 95% of business from Rx sales in tune with the company's apothecary model—agree that third parties are major culprits behind shrinking profits, they still level criticism at their head office. "They simply haven't been able to get us good deals with designated vendors, whether it's purchasing or working with third parties," said Jung.

Indeed there have been strong charges from some MSI franchisees that volume discounts are a myth. The promise of volume discounts from wholesaler Cardinal Health is largely an empty one, they claimed. In one case, franchisees discovered that Kerr, a 200-store chain, was actually getting better prices than the 1,000-plus MSI member stores. Wilusz suggested that MSI does not paint a clear picture of how price breaks work. "If we're considered a group, why aren't we all given the same price?" he asked.

In response, Parrish said, "Our average store is doing about $2 million, and that's already up there with a full-size independent with more sales coming from the front of the store." And the company continues its drive to "aggressively" negotiate rates set by third parties when generic products are introduced and then renegotiating them on a regular basis to ensure the best prices, he added.

The contract pricing agreements continue to be a big boon to his bottom line, said Amato. While he conceded that there's no real advantage when it comes to brand-name drugs, he said that the lower generic prices, coupled with whatever credits are due back to the store, "pretty well negate the 5.5% royalty" paid by a number of franchisees. "There's a big difference between AWP and the actual cost, especially on newly approved generics," said Amato, who doubts that he would have these types of contract prices as an independent.

Most MSI franchisees said they still believe the concept can work. Citing the many advantages that come with being part of something bigger, such as the camaraderie and interchange of ideas among members, many are hoping for solutions to problems such as royalty fees. And, for his part, Parrish said that as he's done since taking over at MSI, he will leave the lines of communication open to members as the company moves ahead with new programs and ideas.

Tina Kyriakos

The author is a writer in Texas.

 



Tina Kyriakos. Pharmacy franchises: Still alluring or losing their luster?

Drug Topics

Apr. 1, 2002;146:39.