Business_Proposal

Business Proposal Ira Johnson, Jr. ECO/561 Economics December 3, 2012 Dr. Caryn Callahan Business Proposal In an effort to serve the CVS Pharmacy’s consumer base better, the need to offer a wider variety of prescription medication selections and options system-wide. In this proposal, assumptions about the elasticity of demand and the market structure for these medications and expanded services will be included. Additionally, how the expansion will increase revenues will be explained. Further, a rationale for determining the profit-maximizing quantity will be provided. Decisions will be made by using the concepts of marginal costs and marginal revenue to maximize profit. A mix of pricing and non-pricing strategies will be suggested. This proposal will also explore options of creating or increasing barriers to entry. Further, increased product differentiation will be discussed. Finally, other way to minimize costs will be explored. Market Structure and Elasticity of Demand CVS retail pharmacies operate in a monopolistic competition market structure. According to Investopedia (2012), the monopolistic competition is, “A type of competition within an industry where: 1. Firms produce similar yet not perfectly substitutable products. 2. Firms can enter the industry if the profits are attractive. 3. Firms are profit maximizers. 4. Firms have some market power, which means none are price takers. Firms in a monopolistic competition sell goods that have either actual or perceived non-price differences. These differences are not so significant, however, that they climate the potential for substitutes. The cross-price elasticity of demand in a monopolistic competition, therefore, is positive or high. Prescription drugs and retail pharmacies are close but imperfect substitutes, which perform the same basic functions but have differences that distinguish them from each other such as location, type, appearance, style, reputation, and quality (Krugman & Wells, 2009). Increasing Revenue In 2011, total prescription sales in the United States increases approximately 3.5% to $319.9 billion from $308.6 billion the previous year. Despite pressure from generic drugs, this increase represents a rise in dispensed prescriptions for 3.99 billion in 2010 to 4.02 billion the following year (Lindsley, 2012, p. 630). This increase, however, is representative of the trend of annual growth of 5% or less since 2007—a result of the recession and consumer response of switching from brand name to generic prescription drugs (Bartholow, 2012). In response to this trend, CVS Pharmacies need to expand their product offerings to include more of the Top 200 prescription drugs to increase revenue by increasing volume sales. To accomplish this goal, automated dispensing and verification systems should be put in place system-wide. Several options are available, including models with counting and error prevention systems; hands-free cassette dispensing and unique double counting; and compact, robotic dispensing systems that automatically label and dispense 35-40% of total orders (Kirby Lester, 2012). Profit-Maximizing Quantity To determine the profit-maximizing quantity, CVS will use marginal analysis. Marginal analysis is a valuable tool for spotlighting managerial decision-making issues, such as improving performance, evaluating business models, determining break-even sales, tracking operating profit margins, and seeing what drives performance (O’Flynn, 2012). According to Huter (2012, p. 1): Calculating the quantity that will maximize profits requires that you understand the economic concept of marginal analysis. Marginal analysis is the study of incremental changes in profit. The quantity that maximizes profit is where marginal profit shifts from positive to negative.  Assuming the quantity is the amount of prescriptions CVS hopes to sell, as sales increase, so do expenses. When those expenses rise to an amount that no longer maximizes profits, marginal profit becomes negative. To calculate the profit-maximizing quantity, the company’s sales and expense reports are needed along with documenting and computer devices or software. Determining the profit-maximizing quantity is a four-step process: 1. Determine profits for each level of sales. For simplicity’s sake, assuming that CVS sells each prescription for $25, as sales increase, so do the costs associated with labor, increased shrinkage, quantity discounts, raw materials, commissions, and other variable costs. Therefore, if the pharmacy sells 20 prescriptions, the profit would be $250; for 40 prescriptions, $350; 60 prescriptions, $550; and for 80 prescriptions, the profit would decline to $500. 2. Determine the marginal profit at each incremental increase in sales. “Marginal profit is defined as the change in profit for each additional unit sold (Huter, 2012, p. 2). Assuming a unit is an increment of 20 prescriptions, increasing sales from zero to 20 prescriptions produces a marginal profit of $250. An increase in sales to 40 prescriptions produces a marginal profit of $100. From 40 to 60, $200; and from 60 to 80, $50. 3. Determine the profit maximizing quantity. In this example, the profit-maximizing quantity is 60 prescriptions. Beyond this point, marginal profit becomes negative because it is likely that variable costs will rise, thereby reducing net profits. 4. Determine where expenses could be lessened and revenue could be increased to optimize sales. Assuming CVS uses an inventory tracking system to reduce shrinkage along with the implementation of automated dispensing and verification systems, the total profit for dispensing 80 prescriptions rises to $600, a marginal profit of $100. To find a new profit-maximizing quantity, the assumption is the marginal profit for selling 100 prescriptions is $675—the profit-maximizing quantity still has not been reached. The sale of 120 prescriptions produces a total profit of $650 and a marginal loss of $25. Thus, the new profit-maximizing quantity is 100 prescriptions. Marginal Cost and Revenue An alternative method for determining the profit-maximizing quantity is to determine where marginal costs equal marginal revenue. Instead of calculating profits for each level of sales, total variable costs, and total revenue are calculated. Marginal costs and marginal revenues are calculated in the same manner as marginal profit, thereby determining the amount of change for each level of sales (Huter, 2012, p. 2). Pricing and Non-Pricing Strategies Because CVS must consider several factors affecting its business, such as suppliers, consumer demands, competitors and their existing products, pricing strategies are complex. Options for pricing strategies may include membership or trade pricing, geographical pricing, penetration pricing, product bundle pricing, discounts, and closeouts. Options for non-pricing strategies include: extended warranties, advertising, longer opening hours, and enhanced service quality (Kimmons, n.d.). For CVS’s pricing strategy options, the recommendation is to employ a mix that includes: membership pricing, geographical pricing, penetration pricing, product bundle pricing, discounts, and closeouts. Membership pricing and discounts reward and encourage repeat business. Geographic pricing allows profit maximization by pricing identical products differently based on regional demographics. Penetration pricing is an effective way of promoting new or unique products at temporary price reductions. Finally, closeouts and bundle pricing can be employed when certain seasonal products must be sold off to avoid a loss (Kimmons, n.d.). Non-pricing strategies should include: advertising, longer opening hours, and enhanced service quality. Advertising draws attention to the brand and makes consumers aware of sales and promotions. Longer opening hours allows the opportunity to service more customers—the fisherman with the biggest net catches the most fish. Finally, the implementation of the automated dispensing and verification systems will enhance service quality, especially in the pharmacy (CVS’s core competency) because they free up pharmacists to counsel the patients. Barriers to Entry The major barrier to entry in the retail pharmacy industry is cost. As an incumbent, economies of scale allow CVS to purchase large quantities at low rates because of long relationships with suppliers and because they are buying in bulk. This benefit gives CVS leeway to lower prices while remaining profitable. New entrants do not enjoy these same perks and would not be able to compete adequately (Anonymous, 2012). Other than cost, no barriers to entry exist in monopolistic competition. Increased product differentiation (discussed in the next section) requires non-price initiatives, which, if unsuccessful will drive CVS retail pharmacies out of the market (Petroff, 2002, Ch. 6). Increased Product Differentiation Strategies for propelling CVS forward in the new era of pharmacy retailing are fivefold (Johnsen, 2012): 1. Each CVS store must be transformed into “health, wellness, and living destinations,” that combine improved product assortment with enhanced store designs. 2. To advance the role of the local pharmacy plays in the health care field. The pharmacists will be required to interact more with customers/patients, providing “total care.” 3. CVS must deliver exceptional customer experiences in all areas of the store. This includes not only the pharmacist and technicians, but also all store associates. 4. CVS must expand across channels by combining superior brick-and-mortar locations with a comprehensive online shopping option. 5. CVS must commit to continual cost containment with the implementation of enhanced point-of-sale systems to improve speed of service and support the implementation of the pricing strategies mentioned earlier. Minimizing Costs The cost-benefits of implementing automated dispensing and verification systems are threefold: First, productivity of individual pharmacists and pharmacy technicians will increase substantially, filling the void for hard-to-fill vacancies, thus, controlling or lowering labor costs. Second, the ability to handle a higher volume of generic drugs will compensate for the consumer trend of shifting from brand name drugs. Finally, each of these machines qualifies for a tax deduction of the full purchase price (IRS, 2012). These cost-minimizing savings can be passed on to the consumer, thereby increasing sales volume. According to Loraine Hawkins of the World Health Organization (2011, p. 21): A second source of evidence comes from internal reference price schemes for reimbursing prescription medicines. These schemes use patient out-of-pocket payments as a driver of medicines price competition. Where prescribers are informed about what patients will pay under reference price schemes, and motivated to minimize out-of-pocket costs to patients, this form of competition has reduced prices. Conclusion Implementation of this proposal will increase revenues while minimizing costs. Although some of the strategies discussed in this proposal are fundamental and need to be returned to, new, innovative strategies, such as the implementation of new technologies. The updated POS terminals and automated prescription drug dispensing and verification systems will increase efficiency, reduce errors, and provide opportunities for enhanced customer/patient experience through better customer service. References Anonymous. (2012). What Are Barriers to Entry' Retrieved from http://www.wisegeek.com/what-are-barriers-to-entry.htm Bartholow, M. (2012, July 10). Top 200 Drugs of 2011. Pharmacy Times. Retrieved from http://www.pharmacytimes.com/publications/issue/2012/July2012/Top-200-Drugs-of-2011. Hawkins, Loraine. (2011, May). Working Paper 4: Competition Policy. WHO/HAI Project on Medicine Prices and Availability: Review Series on Pharmaceutical Pricing Policies and Interventions. Retrieved from http://www.haiweb.org/medicineprices/24072012/CompetitionFinalMay2011.pdf Huter, S. (2012). How to Calculate the Profit-Maximizing Quantity. Retrieved from http://www.ehow.com/how_6713701_calculate-profit_maximizing-quantity.html Investopedia. (2012). Monopolistic Competition. Retrieved from http://www.investopedia.com/terms/m/monopolisticmarket.asp#axzz2E27hn5A0 Johnsen, M. (2012, January 11). Walgreens outlines five key strategies to change the pharmacy retail industry. Retrieved from http://www.drugstorenews.com/article/walgreens-outlines-five-key-strategies-change-pharmacy-retail-industry Kimmons, R. (n.d.). Pricing Vs. Non-pricing Strategies. Retrieved from http://smallbusiness.chron.com/pricing-vs-nonpricing-strategies-14166.html Kirby Lester, LLC. (2012). Powerful pharmacy that’s affordable' Only from Kirby Lester. Retrieved from http://www.kirbylester.com/ Krugman, P. & Wells, R. (2009). Microeconomics. (2nd ed.). Worth Publishers. Retrieved from http://worthpublishers.com/Catalog/product/microeconomics-secondedition-krugman Lindsley, C.W. (2012, August 15). The Top Prescription Drugs of 2011 in the United States: Antipsychotics and Antidepressants Once Again Lead CNS Therapeutics. ACS Chemical Neuroscience, 3(8), pp. 630–631. Retrieved from http://pubs.acs.org/doi/abs/10.1021/cn3000923. McConnell, C. R., Brue, S. L., & Flynn, S. M. (2009). Economics: Principles, problems, and policies (18th ed.). Boston, MA: McGraw-Hill Irwin. O’Flynn, K. (2012). How Does Marginal Analysis Help Business People in Decision Making' Retrieved from http://www.ehow.com/info_7785015_marginal-business-people-decision-making.html Petroff, J. (2002). Monopolistic Competition. Retrieved from http://www.peoi.org/Courses/mic/mic6.html United States Internal Revenue Service. (2012). Bonus Depreciation and Increased Section 179 Deduction under the American Recovery and Reinvestment Act. Retrieved from http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Bonus-Depreciation-and-Increased-Section-179-Deduction-under-the-American-Recovery-and-Reinvestment-Act