No one enjoys dealing with rejection, but “no” can be especially difficult to cope with when it concerns someone’s health. Brittany Smith*, who was diagnosed with Type I diabetes in 2012, knows this to be true. “I didn’t cry when I found out I had diabetes, “ Smith said. “But I found myself sobbing to the pharmacist at the back of a CVS the first time I couldn’t get the medication I needed.” Diabetics rely on the proper medication and medical devices to constantly monitor and maintain healthy blood glucose levels. Smith must constantly replenish lancets, test strips, and needles. In spite of her diligent efforts, a miscommunication between her family doctor and the pharmacy forced her to choose between spending a small fortune on a different brand of medication, or going without it. “Being diagnosed with a chronic illness is shocking, but you can learn to live with it. My medication is one of the few tings that I cannot live without.”

 

Recent reforms in healthcare law have the potential to simplify medication management and reduce costs for patients with chronic illnesses, like Smith, as well as

everyday consumers. Provisions in the Affordable Care Act (ACA), affectionately known as ObamaCare, create financial incentives for providers and insurers to improve patient outcomes and reduce overall costs, as opposed to rewarding physicians based on the cost of services and medications. Healthcare payers are responding to these incentives by working with retail pharmacies to expand their services and adapt the role of pharmacists. Companies like Walgreens, Rite Aid and CVS are aggressively investing and trying to expand their retail pharmacy businesses. Their goal is to make healthcare services cheaper and more convenient for consumers, while also providing medication counseling. At they same time, they are helping to meet medical service demands that the current infrastructure cannot support well, while still turning a handsome profit. Healthcare payers are please because they will now benefit financially from improving patient outcomes. The nation should feel the same way, given that this model has strong potential to lower the unsustainably high cost of healthcare. Expanding retail pharmacies is not just a win-win situation, it’s a quadruple win. It is remarkable that this scenario could arise simply from properly aligned industry incentives. Is it too good to be true?

 

Time will tell, but the present is filled with promise. The changing healthcare landscape and the retail pharmacy model are poised to improve the consumer experience and better meet demands. The revolution will not come easily; healthcare retailers will face substantial competition from aggressive competitors and will remain beholden to price factors beyond their control. For consumers, however, the change has lasting transformative potential.

 

Why Now?

Retailers have compelling economic reasons for investing in or expanding their investment in the retail pharmacy space. They anticipate increased demand for healthcare because of the ever-aging population and because 30 million new customers are expected to enter the healthcare market thanks to Obamacare. Data indicates that consumers will buy more services if they make them cheaper and more convenient. A Center for Medicare and Medicaid Services (CMS) study found that many people decline to pay for some preventative care solely because of cost. By reducing the costs, retail pharmacies can recapture that lost business while improving public health.

The time is ripe for the rise of retail pharmacies. Americans have begun taking more responsibility and initiative in their healthcare, albeit not necessarily by choice. Out of pocket costs increased 250% in the last five years. The ACA has led employers to switch to more high-deductible plans. Last year 13% of employers offered such plans, up from 3% in 2006. This change may be unpopular, but passing off costs created an unsustainable burden on the system. Increased deductibles are forcing people to take a more active role in managing their healthcare.

 

 

A Promising Prognosis

Retail pharmacies can make services and medications offered under the century-old traditional model cheaper and more accessible. Physicians, depending on the patient’s plan, are reimbursed by insurance companies or the government for volume of business, so the amount they bill directly correlates to their bottom line. In contrast, pharmacies make higher profit margins on generic medications than on more expensive brand names, so they are incentivized to encourage generic alternatives. For example, CVS has gradually increased the amount of prescriptions it fills with generics, rising from 71.5% in 2010 to 83% in 2013. Minor medical services, like administering vaccines, conducting physicals, and treating non life-threatening illnesses, are much cheaper at a pharmacy than at a doctor’s office or hospital. Rapidly improving medical technology makes it easier for pharmacists to diagnose illnesses, expanding their range of services and saving customers expensive trips to the doctor. Visiting a retail pharmacy costs $79-$89 on average, less than half the cost of the typical doctor visit. Picture this: the next time you fall ill, you can drive or walk five minutes to your nearest pharmacy, likely closer than your doctor’s office, get diagnosed, and pick up your medication on the spot. The trip cost you less time and money, and you’re home again before you can say “Uncle.”

 

In addition, retail pharmacies plan to offer services the current healthcare system cannot provide, such as medication management and adherence. While those terms may not sound significant, they are vital for people with chronic illnesses. Consider Smith, who notes, “When I think of management, I laugh about the ‘I have diabetes, but diabetes doesn’t have me’ phrases. No, it doesn’t run my life or prevent me from doing most things I want to do, but if I want to live a long, healthy life I have to make choices every day because of my illness”. She has to test her blood sugar levels 12 times a day, and administer an insulin shot when necessary. Along with maintaining and carrying a supply of medical equipment, Brittany has to have snacks and glucose tablets with her just in case. She is a model patient, and if every diabetic followed her regimen, the nation could potentially save billions on healthcare costs. Analysts estimate America spends $290 billion on healthcare services that could have been avoided if patients adhered to the medication they were prescribed. There is a clear need to help people manage their medicine, but meeting that need is not practical for doctors. They are dramatically overqualified, so it would not cost effective for them to fulfill this role, nor would it be convenient for patients. In contrast, national retail pharmacies can invest in the technology, like smartphone apps, websites, and backend software to help schedule prescriptions, notify patients when they are ready, and remind them to take their medication. Doctors would be hard-pressed to offer comparable services.

Side Effects

Fluctuations of brand name and generic drug prices have a significant impact on pharmacies’ profitability. They have no way to control significant price fluctuations; the best they can do is plan for them. Brand name drugs are considerably more expensive and are sold on lower margins. Consider that in 2009, generics accounted for only 9% of revenue, but 56% of profits for the biggest three wholesalers, while brand drugs accounted for 88% of revenue and only 38% of profits. The reason for this disparity is that the largest pharmacies can buy generic drugs directly from the manufacturers because they have the negotiating power and warehousing capabilities. They are uniquely poised to do this. Most other generic retailers, including supermarkets, small independent pharmacy chains, and physicians’ offices buy generics through drug wholesalers like McKesson, AmerisourceBergen or Cardinal Health. Nearly every drug retailer purchases brand name drugs through a wholesaler. Switching to generics can help make the retail pharmacy model more profitable, especially relative to competitors who lack comparable negotiating power; however, fewer drugs are expected to go off-patent in the coming years, which means generic substitutes may not be available. Those that are available may not be much cheaper, as the same economic principle applies to generics as to brand names. If they have a monopoly they will exploit it. Generics that are launched with exclusivity are priced just 10% below the reference brand.

 

 

 

Further complicating the economics for retail pharmacies, costumers are less concerned with brand loyalty than they are with cheaper prices. The Walgreens-Express Scripts dispute serves as a reminder of this reality. When the two companies parted ways because of a contract dispute in 2011, Walgreens lost customers and roughly $4 billion in revenue, or about 21 cents a share. Customers left Walgreens, not Express Scripts, because they cannot make decisions about their plan benefit manager, and were not infuriated because they could easily find another pharmacy.

 

Today’s market is highly competitive. Pharmacies are expanding, making it more convenient for people to go to any one. They all offer the same basic services and range of medications at similar prices, so location is key. Walgreens opened its first location in downtown Los Angeles in 2010, right across from the Rite Aid on 7^th and Broadway. In 2013 the company opened its second location on 5^th and Broadway, once again right across from a Rite Aid. Walgreens, CVS Rite Aid and the like are making strong efforts to acquire and retain customers. Their websites encourage visitors to create accounts to manage their prescriptions and take advantage of rewards programs. In comparison, Target, which has been less aggressive in its entrance to the market, displays its prices online and makes it easy to compare services. They make less effort to encourage signups, treating health services more like an impulse buy. Target’s profitability depends much less on its pharmacy business than a company dedicated to wellness though. Retail pharmacies must find ways to retain customers in a competitive market, because their services are so comparable that it is difficult for any one to stand out.

***

The retail pharmacy industry is trending in a very promising direction for consumers, which is refreshing given the state of the American healthcare system. There is clear opportunity for companies looking to break into this market or expand their business, but much of their success and profitability will hinge on finding ways to create customer loyalty. Retail pharmacies must generate enough demand in sufficiently large markets to avoid out-competing one another.

There will be more pharmacies in the future. May not hold promise to people with chronic conditions that they can get the specialty medication they need anywhere. But their options are improving, it’s a great start that stuff is cheaper and more convenient. Future will test how well these incentives are aligned.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, passed in 2010, was the legislative response to the Great Recession. Although it imposed the most significant changes to our financial regulation system since the Great Depression, this 2,300-page piece of legislation will do precious little to fix the problems that caused our financial collapse, or to prevent the next economic crisis. Some provisions of the law contradict other laws, and many of the reforms that seemed necessary and sensible have been gutted because they either were impossibly strict or unwelcome by bankers and regulators. America simply is not ready to reconcile the “dream” of owning a home with the realities that reform necessitates.

The Good

In its infancy, Dodd-Frank had the potential to effect some much-needed change. The act was designed in part to incentivize banks to make less risky loans to homebuyers. The first way it did this was by incentivizing lenders to originate Qualified Mortgages (QM) and Qualified Residential Mortgages (QRM).

To qualify as a QM, the borrower must have a debt-to-income ratio below 43%; this means that the monthly mortgage payment cannot exceed 43% of the borrower’s monthly income. QMs don’t require a down payment, and prohibit many predatory lending practices we discussed, such as balloon payments and interest-only loans. Lenders must also verify the income and financial resources of the borrower.

A QRM is very similar to a QM, but involves stricter underwriting requirements. Originally borrowers were required to pay a 20% down payment and their monthly mortgage could not exceed 36% of their monthly income. These are the “safest” mortgages, because the borrower is much less likely to default if he meets those standards.

Dodd-Frank incentivizes lenders to make these “safer” loans primarily through the Risk Retention Rule, and the Ability to Repay Rule. The Risk Retention Rule does what you might expect it to do: it requires banks to retain 5% of the risk for any asset-backed security, say a mortgage-backed security. This forces lenders to retain some “skin in the game,” fixing some of the misaligned incentive structures. The rule also prohibits lenders from hedging this risk. Lenders want to avoid having risk on their books because the more risk they retain, the more reserve capital they must keep on hand that they can’t use to make more money. QRMs are exempted from this rule, however, making them a more appealing option for banks.

The Ability to Repay Rule requires that lenders make a “reasonable and good faith determination based on verified and documented information” that the borrower can repay the loan. A borrower’s credit history, current income, expected income, and debt-to-income ratio can all contribute to his ability to repay. While it’s baffling that Congress passed this requirement in 2010, it is nonetheless a step in the right direction. Lenders who fail to verify a borrower’s ability to repay can be held liable for damages if the mortgage forecloses. This significant change will force lenders to weigh the potential costs of multi-million or multi-billion dollar legal settlements against expected returns on a very risky mortgage. Both QMs and QRMs are exempted from this rule. Banks can thus avoid the liability if a borrower defaults by issuing sounder mortgages.

The Bad

For starters, legislators drafted Dodd-Frank in very broad terms, instead creating agencies, like the CFPB and others, to hash out the specifics of how the reforms should work. These details are probably important considering they pertain to an industry that deals with numbers and affects people around the globe. Better leave it to the experts then, right? Well, the U.S. had many “experts” and regulatory agencies in place in the build-up to the Great Recession too, but they didn’t do much to prevent the housing bubble, even when explicitly warned.

Further, key provisions in the Dodd-Frank bill that passed in 2010 were drastically changed or removed by the time parts of the law were finalized in 2014. Regulators have finalized and implemented a little more than 50% of the reforms proposed by Dodd-Frank four years after the act passed. They loosened QRM requirements, which originally required a 20% down payment and 36% debt-to-income ratio, to require no down payment and a 43% debt-to-income ratio because the lending industry argued the original requirement would make these loans impossible for most Americans to obtain. With a few exceptions, a QRM is functionally the same as QRM; yet QRMs remain exempt from the Risk Retention Rule while QMs do not.

Further, lenders of all home mortgages issued by the government are exempt from this rule. This includes mortgages originated by the FHA and those sold to Fannie and Freddie; this accounts for 85% of all home mortgages. Thus, banks in practice don’t retain any “skin in the game” for a majority of the mortgages in the market, but taxpayers do (again). Most of these mortgages do not qualify as QMs or QRMs either.

Here’s where things get ugly

With Dodd-Frank also cam a new interpretation of the 1968 Fair Housing Act. The law says lenders must show they make a good faith effort to serve borrowers outside of QM territory. They can be sued if their lending practices promote disparities or unequal treatment based on race, ethnicity gender or age, but previously we interpreted the law to imply lenders must intend to discriminate against borrowers. Dodd-Frank indicates that a potential litigant does not need to prove intent to hold a lender liable for creating a “disparate impact.” Lenders are unsure of how to reconcile QMs and showing ability to repay while avoiding any detectable disparate impact among borrowers. So while the law strongly incentivzes(ed) lenders to make safer loans, in a way it also punishes them for doing so. Industry officials asked HUD to clarify the law and its intent, and HUD politely declined. Apparently HUD officials felt the courts would be better equipped to do their job.

 Concluding thoughts

Americans might be doomed to housing crises for a long time to come as long as we hold on to the dream of owning a home. The reality is that not all people are qualified to get a mortgage. If questionable financials are not a good indicator, perhaps the fact that many borrowers didn’t bother to read the mortgage contract they signed is more telling. Homeownership certainly provides widespread economic benefits for our country. As long as our government plans to make homeownership a reality though, it must acknowledge the inherent risk of this policy and find a more practical way of protecting the public from it.

Whether you buy a house, a pair of shoes, or dinner out at your favorite restaurant, the sticker price is never the price you pay. The same is true for businesses calculating exactly how much a minimum wage hike might actually cost. Beyond the obvious increase in payrolls for workers who would move from around $9 an hour to more than $13 are a host of hidden costs. Let’s consider.

Anyone who’s received a paycheck probably noticed the roughly 8% missing for Federal Insurance Contribution Act (FICA) taxes. This includes a 6.2% deduction for Social Security tax and a 1.45% deduction for Medicare tax. What some people may not realize is that employers are required to match the amount deducted from each employee’s paycheck for these taxes. The employer contribution increases if a worker’s wage increases.

To keep things simple, consider an employer’s total cost for an employer who makes the current $9 an hour minimum wage and works 30 hours a week (or 120 hours a month), and how it would rise if Los Angeles accepts Mayor Garcetti’s proposed wage increases. Staring in January, an employee would earn about $150 more a month, but this would cost the employer roughly $167 more per month; a little more than $200 each year in FICA taxes alone. Similarly, by 2017 that same employee would earn around $510 more a month, but cost the employer $550 a month. This amounts to another $500 the employer must pay annually in taxes, in addition to about $6,100 more it would pay in wages. Consequently, a 47.2% wage increase for employees translates to a 47.2% increase in the cost for their employer to pay them those additional wages.

An extra $6,600 a year might seem insignificant compared to some businesses’ total revenues, but the full effect of this increased cost largely depends on a business’s size. Does a company employ 10 people, or 100? The annual difference in an employee’s cost will add up quickly.

Thus, a wage increase of $4.25 an hour would actually cost employers paying minimum wage about $4.60 more an hour. This does not factor in other expenses that increase in conjunction with wages; at a minimum employers must also account for increased premiums for general liability insurance and workers’ compensation insurance.

 

During times of recession Americans are less than keen on going shopping—no surprise here. Even when the economy is booming, most Americans never weigh the costs and benefits of buying alligator skin boots, belts or bags, wallets or watches. No matte

r how well the economy is doing, $2000 for Gucci alligator skin loafers or $100,000 for an alligator skin Birkin bag by Hermes, one of the most prominent players in exotic tannery business, never seems worthwhile. Apparently during recessions the wealthiest Americans are hit hard too—right in their $11,000 Burberry alligator skin wallets; but that’s just fine by the alligator population.

As it turns out, sales of alligator skin goods plummet during recessions. Economists first noticed this trend during America’s most recent financial crisis in 2009. There is little available data concerning alligator populations in the US, though experts generally believe that the total population has steadily increased since the 1970’s. Louisiana is home to one of the largest alligator populations in America, and the industry makes a somewhat significant contribution the state’s economy. Louisiana’s Department of Wildlife and Fisheries website has an entire menu section dedicated to its “Alligator Program” that’s separate from information about other wildlife. Maintaining a healthy commercial farming population requires alligator farmers to rent helicopters to scout nesting areas, wade into marshes to collect the eggs (and potentially confront angry female alligators), and invest considerable time and energy into raising them in captivity. Bottom line: if hides aren’t selling farmers are losing a lot of money.

During the Great Recession many, if not all, of the state’s alligator farms experienced serious liquidity issues and worried about their business’s solvency going forward because the prices tanneries and high-end fashion houses were willing to pay for hides dropped so quickly. This industry was affected so severely that Louisiana’s Alligator Management Program report since 2008 lists an asterisk next to the revenue data from that year stating, “Worldwide economic recession caused alligator hide demand to decrease dramatically.”

From 2002-2007 the total revenue from alligator hides increased sharply, reaching a peak value near $55 million. Total revenues decreased dramatically in 2008, rebounded slightly in 2009, and then dropped again in 2010; revenue fell to a fifth of what it was in 2007. These drops in revenue directly correspond to decreases in GDP the both Louisiana and the United States experienced in 2009.

This correlation exists for earlier recessions as well. Commercial alligator farming was prohibited from 1965-1972 in an effort to protect the alligator population, so Louisiana only has data available beginning in the early 1970’s.  Quadrupling oil prices, high unemployment and a high inflation rate contributed to significant stagnation in the the U.S. economy from 1973-1975; alligator hide revenues in Louisiana also decreased by about 58% during this time. Revenues rose dramatically again in 1976, corresponding to an increase in GDP for both Louisiana and the U.S. The disparity was extreme: in 1975 revenues from farm alligator hide harvests totaled $3,597, compared to $34,259 in total revenue in 1976.

Alligator skin revenues in Louisiana dropped significantly again from 1981 to 1982, corresponding to another global economic slump in the early 1980s. When the stock market crashed in 1987 and the business cycle dipped from 1990-91, alligator hide revenues were along for the ride, stagnating from 1989 to 1990 and then decreasing sharply until 1992. Finally, total revenues decreased again from 2000 to 2001, which corresponds to a decrease in Louisiana’s GDP from 1999 to 2000, the burst of the dot.com bubble in 2000, and the September 11 terrorist attacks in 2001. Revenue from alligator hides in Louisiana is currently on the rise again, at a time when IPO valuations and the S&P 500 are reaching record highs.

 

It seems somewhat counterintuitive that a decrease in revenues from a luxury good would correlate so well with economic downturns. Only the wealthiest portion of the population can afford goods made from alligator hides, and people typically assume that they are insulated from economic recession or hardship. Yet, this niche luxury goods industry experiences significant declines during periods of economic recession. While it’s no great tragedy that someone won’t be able to purchase exorbitantly-priced shoes, it is perhaps comforting to note that recessions and financial crises force every man to tighten his belt, whether it’s made from alligator leather or elastic.