Government vs Free Market Solutions

cropped-bob-shapiro.jpg   By Bob Shapiro

I have written several times about how we should allow the Free Market to provide services rather than give the job to a government agency, mentioning ObamaCare and Medicare specifically. I have said that the Free Market will produce better, more efficient, more innovative results.

Now, it’s not that the people working for the government are trying any less hard to do a good job, compared to their private sector counterparts. When I worked as an outbound mail manager at a large mail service

company, I met in a seminar with a couple dozen Regional Managers from the Postal Service and from private companies. I remember being very positively impressed with the Post Office people.

Outbound Mail

But government solutions suffer from a pair of anchors which prevent them from being the best solution.

  • The Law – their mandate – likely is not framed to achieve the best results. Indeed, it is impossible even to know what the best results would be without the feedback that the Free Market can provide. It is only through competition that all possible ideas can try to beat out all the others.
  • The Incentive structure of a government agency pushes results in directions other than the best for the customers. For example, “Job One” for the FDA is to not allow a career ending drug to reach the market, even if that means delay – or total blockage – of a life saving treatment.

In a Free Market, companies compete. No two ideas of how to do things are exactly alike. No idea is static, but rather it always is changing. Some companies are rewarded by customers with profits, and they continue to compete. Others lose money and go out of business as customers vote with their pocketbooks on which offering is best in their eyes.

Bear with me as I recount a personal experience of how I tried to be different from other businesses, and my customers rewarded me for it. But, eventually, the government regulations were changed to prevent any use of my methods.

Many years ago, I was partners in a retail pharmacy, The Friendly Valley Pharmacy, in the far northern suburbs of Los Angeles. Medi-Cal, the state Medicaid Prescription Program used to pay for prescriptions at the rate of AWP (Average Wholesale Price) plus a professional fee of $2.40.

They allowed a maximum of a 100 day supply, although their rules allowed you to cut the quantity to 30 days, at your discretion. Most stores in the state did cut quantities in order to get the $2.40 fee, as well as force the patient to make a trip to the store, every month.

That’s not how I worked!


One day, I got a phone call from a Medi-Cal reviewer asking why my average quantity on prescriptions filled was so far above the state average. Initially I was very put out that the caller was a pharmacist – how dare he try to force me to release trade secrets to the competition.

He assured me that he didn’t work in retail, and that any information I gave would be strictly confidential. So, I calmed down and started to explain my business logic.

Prescription medications fall into one of two categories – either they are for acute illnesses, like antibiotics for an upper respiratory infection, or they are for chronic conditions, like blood pressure medication.

When the type of medication, and the patient’s profile, made me expect that this was a medication that the Medi-Cal patient was likely to be taking for years, I would call the doctor and ask if I were correct. If the doctor said yes, then I asked if I could dispense a full 100 days supply which the plan allowed. Almost always, the doctor said yes.

So, why would I be willing to give up more than $20 a year per medication, in lost professional fees? Money!

No pharmacy at that time paid AWP – wholesalers regularly offered a 10% discount if you paid your bills on time. And if you bought the drug direct from the manufacturer, the price usually was 15% under AWP, plus a 2% discount for timely payments.

Since I was making the process much more convenient for the patient – and patients talk – I had a thriving business. (I also was a discount pharmacy, when such a thing had meaning.) While filling a prescription for a 100 days supply, compared to only 30 days worth, I had more time available for other customers’ prescriptions – my productivity was vastly better than my competition.

I had a high volume neighborhood pharmacy, and this allowed for additional cost savings. Many medications were available not only in 60s or 100s, but they also might come in bottles of 500 or 1000. A very few also came in 5,000 tablet size bottles. Naturally, a larger size also came with a lower unit price to the pharmacy, ranging from 3% on the 500 up to over 10% lower than the 100 price for a 5,000 bottle.

By getting the doctor’s OK to give a full 100 days’ supply, I:

  • Saved the state $20+ a year per medication per patient in my foregone professional fees
  • Saved the state the cost of processing 8 claims a year because I submitted many fewer claims
  • Saved the patient 8 extra trips to my store to pick up prescriptions
  • Made time for myself to fill 8 additional prescriptions a year
  • Was able to get additional discounts below AWP so that, for each fill, it was possible for me to make a profit of between $5 and $15 for a single order.

Everybody should have been very happy, but this is not always the way the world works. Today, Medi-Cal pays AWP – 17% (or actual acquisition cost) plus a $7.25 professional fee. Pharmacies have zero incentive to save money on drug purchases, since Medi-Cal claws it back, and the 3X increase in the fee is well under what inflation would suggest (especially since ordinary purchasing discounts have been lost).

The result is that everybody has lost by changes in the reimbursement schedule. The state has to handle more claims, the patient has lessened convenience, and the stores make less profit.

Don't Settle

The new way that Medi-Cal pays for medication is not the cheapest for the State of California. It is not the best for the patients. And, it stifles any innovation on the part of providers to make the system better. This is not because of some evil plan. It’s just that government solutions cannot be as good as what the Free Market would provide.

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