Among the most significant reforms proposed by recently released Harper Competition Policy Review is the removal of regulatory restrictions that greatly limit competition in the community pharmacy sector. But implementing the recommendation will require politicians who are up for a real challenge.

Any changes to how the pharmacy sector works involves taking on what has been described as “the most powerful lobby group you’ve never heard of.” The Pharmacy Guild of Australia, which represents the interest of pharmacy owners, is widely perceived as one of the most influential lobby groups in Australia.

Monoploy rents

Australian pharmacies are currently protected from competition by two sets of government regulations that form part of what’s known as the Community Pharmacy Agreement. Negotiated every five years between the Federal government and Pharmacy Guild of Australia, the agreement regulates most aspects of the pharmacy sector, from remuneration for supplying government-subsidised drugs to rules about the ownership and location of pharmacies.

The ownership rules disallow non-pharmacists from owning a pharmacy. So they effectively keep supermarkets and large international pharmacy chains, such as the UK’s Boots, from owning pharmacies in Australia.

The location rules were introduced as part of the first pharmacy agreement in the early 1990s. It prevents new pharmacies opening within a kilometre and a half of an existing pharmacy.

These ownership and location restrictions have effectively prevented new entrants into the sector and created what economists call monopoly rents for existing pharmacy owners. Monopoly rents represent the benefits that an industry gains from politically-enforced regulations to restrict competition.

While reform of the pharmacy sector by removing these restrictions has been championed by commentators from as diverse political backgrounds as Paul Howes and Janet Albrechtson, none of Australia’s politicians from any of the major political parties have so far taken up the cause.

Report after report

The competition review recommendation is unequivocal:

the pharmacy ownership and location rules should be removed in the long-term interests of consumers.

And it comes after a similar recommendation from the 2014 National Commission of Audit report, which advocated:

opening up the pharmacy sector to competition, including through the deregulation of ownership and location rules.

Then there’s the report from the Australian National Audit Office (ANAO), which conducted a performance audit of the administration of the fifth Community Pharmacy Agreement (ending June 2015). The ANAO found so many shortcomings in administration of the agreement by the Department of Health that it was:

not well positioned to assess whether the Commonwealth is receiving value for money from the agreement overall.

The ANAO report quantified the remuneration pharmacies have received from government since the early 1990s, when the first Community Pharmacy Agreement was put in place. The figure below shows payments pharmacies receive for dispensing and mark-ups (the amount of money added to the price of drugs, to cover overheads and profit) have tripled from around $750 million in 1991 to over $2 billion by 2013 – even after adjusting for inflation.

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This growth is due to much higher volumes of dispensing due to a combination of population increase, ageing, and expanded prescribing from newer classes of drugs, such statins. But as well as the increase in amounts paid to pharmacies each time a drug is dispensed, government payments are now around 20% higher in real terms than in the early 1990s, due largely to greater pharmacy remuneration from mark-ups.

And while total remuneration has substantially increased, restrictions on competition mean there are actually fewer pharmacy businesses in Australia than when the first community agreement was negotiated in the early 1990s.

Who wants to be a millionaire?

The ANAO report also provides a distribution breakdown of this remuneration across different types of pharmacies. As the graph below shows, around 18% of pharmacies receive more than $1 million in remuneration from dispensing drugs listed on the Pharmaceutical Benefits Scheme. A comparison of the 2012 and 2013 financial years indicates a further 140 pharmacies moved into this top-earning bracket.

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The high profitability of established pharmacies mean business sale prices for inner city and suburban pharmacies can run into the millions. And this high purchase price locks out many pharmacy graduates from ever owning their own business. It also means new entrants are saddled with levels of debt that turn what should be profitable business into marginal ones.

All this creates what might be termed a cycle of rent-seeking: while the ownership and location rules protect existing owners, the next generation of pharmacy owners will have to buy their businesses at inflated prices. And this makes new owners seek ever more protection from competition to make their business profitable and, in some cases, viable.

This might also partly explain campaigns such as “Pharmacy Under Threat”, which was run by the Pharmacy Guild of Australia. It was held in the middle of the last Federal election campaign against the relatively modest reforms proposed by the former government to accelerate reductions in price of generic drugs.The Guild claims that a petition distributed through a network of community pharmacies attracted 1.2 million signatures.

Of course, the lack of competition in the sector comes at a cost to the consumer, both in terms of the choice of where they can shop and in the prices that must be paid. As the ANAO report demonstrates, a packet of aspirin, which may cost as little as $3 in retail marketplace costs up to $12 when it is dispensed under the PBS.

Still, while the economic arguments for increased competition are strong, the politics of implementing community pharmacy reforms remain another matter. As one of history’s most astute political commentators Niccolò Machiavelli once observed, there is:

nothing more difficult to plan, more doubtful of success, nor more dangerous to manage than a new system. For the initiator has the enmity of all who would profit by the preservation of the old institution and merely lukewarm defenders in those who gain by the new ones.

It’s this challenge that faces any reform-minded politician wanting to introduce more competition into Australia’s pharmacy sector.