Editor's Note: The Berbatis research now takes us into the Australian scene, where it now becomes more relevant and valuable.
Appreciate that this material is an extremely valuable resource, and that it has been published freely, in the interests of Australian pharmacists and their leaders.

1.0 Household customers of Australia's supermarkets

The percentage of visits by households to food outlets in Australia (Table 1) is in the same order as the retail food sales. The disproportionately high percentage in the 'Others' category reflects the much lower sales per visit in the smaller independent grocers (mean c. $30per customer) compared with the large supermarkets ( mean c. $90 per sale).
The decline in percentage visits to Franklins reflects the break-up and sale of Franklin stores in 2002.

Table 1. Australia's supermarkets by national percentage of customer visits .
(source : Safe 2003, based on AC Nielsen research).

1.1 Expansion and efficiencies in Coles and Woolworths
In October 2003 Woolworths Ltd and Coles Myer Ltd were Australia's 10th and 13th largest public companies with market capitalisations of $12.1 billion and $10.4 billion respectively (Table 1).
They are conglomerates with many types of business but Coles and Woolworths supermarkets are by far their biggest generators of sales and profits .
Their total national share of retail grocery sales is more than 77% .
Competition in the industry is checked by the Australian Competition and Consumer Commission (ACCC).
They have expanded with varying success into retailing fresh foods ( fruit, vegetables and meats ) in 1987 , liquor, clothing, electronics , stationery and fuel in the 1990s.
They provide 60 per cent of Australia's total $740 million confectionery retail sales (Safe 2003).

Table 2. Woolworths and Coles Myer outlets in Australia in July 2003.
( Sources: annual reports and ABN AMRO, 2003; Clegg a, 2003; Evans,2003)

Woolworths has performed better by percentage earnings than Coles in all comparable divisions of the companies (Tables 3 and 4) .
Woolworths' market capitalisation has grown much faster than Coles since 1990 .
In 1997 Woolworths opened fuel outlets to sell petrol, an essential commodity , at discounted prices as an incentive to attract or retain customers ( Brown,2003) but in 2003 Woolworths growth stalled while Coles has grown ( Jimenez a, 2003) by rapidly increasing the number of food and liquor outlets and expanding into other markets such as stationery, electronic equipment and fuel even at the expense of lower rates of earnings ( Gottliebsen a, 2003).

Earnings will increasingly depend on reducing costs and expanding sales other than food and liquor. Rationalising the 'supply chains' to supermarkets from the producer or manufacturer will be achieved by rationalising distribution and employing new technology (Gottliebsen, 2003; Mills,2003; Chong, 2003). These efficiencies will result in predicted savings up to $425 million each annually by 2008 to the extent they will "…overtake the banks as the great profit-drivers in the next decade…" (Gottliebsen b, 2003).
Woolworths reported a 5.7% rise in supermarket sales for the September 2003 quarter in food and liquor to $5.695 billion ( Jimeneza , 2003) . Petrol increased correspondingly by 39.1% to $0.52 billion , Big W by 11.8% to $0.66 billion and electronics by 14.4% to $0.22 billion.

Table 3. Woolworths financials : 2002-2003 and forecasts. (source : ABN AMRO Australia 15 August 2003)

Coles-Myer Ltd data (Table 4) including the initial estimated petrol sales in 2003 after Coles agreed with Shell to offer discounted priced petrol through Shell stations and .
Fuel outlets serving Coles customers will increase from 150 to 580 in the 12 months to June 2004.

Table 4. Coles Myer Ltd financials : 2002-2003 and forecasts. (source : ABN AMRO Australia 19 Sept 2003).

In community pharmacies , medicines are the predominant source and earnings and together with other products , sales nationally to June 2002 totalled $9.27 billion (Table 5).

2.0 The special value of the Mayne Group in 2003 to Coles and Woolworths.
The Mayne Group is a public company with a market capitalisation of $2.76 billion in late October 2003 . It has interests in a diversity of health activities including pathology services, medical centres, diagnostic imaging services, medical centres , a generic drugs business and a pharmacy wholesaler incorporated into Mayne after a takeover of Fauldings Ltd .
After years of struggling with private hospitals , Mayne sold them in early October 2003 for $812 million to a private consortium (Clegg b, 2003).
Mayne's current management team is focusing the company on generic drug manufacturing .
The pharmacy wholesaling business is being bid for by New Clicks, a South African public company which owns a string of Priceline health and beauty shops and seven pharmacies in a number of states. Woolworths and Coles are also reported to be interested in acquiring the pharmacy wholesaler.
The wholesaler would yield to a buyer a business with $1.94 billion annual revenue, a 36 % share of the market against API and Sigma, an intimate insight into Australia's community pharmacies while Coles and Woolworths waited for deregulation of pharmacy and the potential to become the distributor in the supply chain of pharmaceuticals to supermarket pharmacies.
This was the situation at the time of preparing this report .

3.0 The values of community pharmacies to supermarkets and shopping centres
This section considers valuing community pharmacies by various methods so as to appreciate the approaches public companies may take.
It is important to recognise the big differences between the capitalisation of Australia's community pharmacies when valued as individual pharmacies compared to applying the same multiples to the earnings of the national sales of community pharmacies as those of public companies such as Coles and Woolworths.
The total value of community pharmacies in Australia may be estimated by a number of methods .
The following estimates of the value of all pharmacies are based on six approaches :
(i) the sum of the average market price paid by pharmacists for individual pharmacies multiplied by the total pharmacies ,
(ii) multiplying the industry average earnings on national pharmacy sales by the Price/Earnings (P/E) multiple for the three main supermarket public companies in Australia,
( iii) an individualised additional market capitalisation applicable to Woolworths and Coles Myer by applying the respective P/E to the extra or unduplicated sales of pharmacy products and services notionally attributable from national pharmacy sales categorised into the various products and services, (iv) an additional market capitalisation to Woolworths and Coles Myer by applying a notional increased earnings to the products and services based on transferring the efficiencies from the supermarkets to the supermarket pharmacies located in the same supermarket premises.
Two further approaches involve values based on
(v) the estimated cash flow and capital losses sustained by shopping centres from the relocation in the same shopping centres of pharmacies into supermarkets and
(vi) the loss to Australia's population notionally incurred by the relocation of pharmacies into supermarkets. Data from the National Pharmacy Database Project (NPDP,2003) were adapted where appropriate to each of the approaches

3. 1 Methods for estimating capitalised values of community pharmacies in Australia
It is important to recognise that the total 'market value' or capitalisation of Australia's community pharmacies based on the market prices paid for pharmacies is much lower than the 'market capitalisation ' when the same multiples of earnings as those used for valuing public companies are applied to the total pharmacy profits or earnings .
The following models are used to estimate the capitalised values by methods based on the most likely alternative pharmacy structures and the latest published or available data from reputable sources.

The following estimates of the capitalisation of pharmacies are generated from the following four methods. They are simplified methodologies so the practical features can be easily understood.

Method 1 : the simplest method for estimating the capitalised value of Australia's community pharmacies is to adopt an average net value or 'market price' or the Pharmacy Guild's estimated average $1.3 million for each pharmacy representing the goodwill, stock, fixtures and fittings multiplied by the approximate total 4,900 pharmacies operating for the 12 months in 2003 in Australia .
This totals $6.37 billion.

Method 2 :in order to estimate a market capitalisation for community pharmacies in the same way as public companies, the same Price / Earnings (P/E) used for valuing public companies such as Woolworths, Coles or FAL may be used to multiply the total estimated earnings ( assumed to be the same as net profit) of Australia's community pharmacies.
The estimated market capitalisation is as follows : the unweighted P/E of 22.4 for these companies (Weekend Australian, 2003) is applied to the Guild's average net profit ( or earnings) of 6.5% of the total annual sales reported by Australia's pharmacies in the National Pharmacy Database Project (Table 5). This equals 22.4 times 6.5% earnings of $9.27 billion or a total market capitalisation of pharmacies of $13. 50 billion. In comparison Woolworths market capitalisation was $12.08 billion, Coles Myer $10.44 billion and Foodland Associated (FAL) $2.2 billion at close of trade on 24 October 2003 (Weekend Australian,2003).
Retail grocery sales is the main source of earnings of these companies but they have other sources of earnings (Tables 2-4).
Analogously , prescription medicines is the major source of earnings for community pharmacies but they also have smaller sources of earnings (Table 5).
Major assumptions are :
(1) all national sales of Australia's community pharmacies are transferable to the respective public companies,
(2) that the same 6.5% earnings to the added sales can be transferred from community pharmacies to supermarket pharmacies,
(3) the average P/E of the public companies is maintained at current levels and
(4) the market applies the same P/E to the earnings of community pharmacies as applied to the market capitalisations of the public companies.

Table 5. Australia's community pharmacies: reported estimated annual sales in 2002
(source : National Pharmacy Database Project , Sept 2003).

Method 3 : in order to overcome the duplication of products sold by pharmacies and supermarkets a more precise method to estimate earnings is to approximate a notional proportion of 'extra' or attributable sales for each category of sales in pharmacies (Table 5) which can be added to the sales of Coles and Woolworths.
For example, the proportions of each category are 1. 0 (or 100%) of 'prescription medicines' sales of $5.93 billion , a notional 0.6 of non-prescription medicines or $0.76 billion, a notional 0.5 of 'medical aids' or $0.10 billion and a notional 0.2 of 'other sales' or $0.28billion .
That is $7.07 billion sales annually in the supermarket pharmacies may be added to supermarket sales . Applying the same Guild average 6.5% earnings for community pharmacies to supermarket pharmacies produces $0.46 billion earnings.
Second, the market capitalisation is individualised to the P/E of Woolworths with a P/E of 19.2 to the $0.46 billion produces an added market capitalisation of $8.8 billion to Woolworths .
For Coles Myer ( P/E 30.2) the added market capitalisation of $13.9 billion represents the total unduplicated sales from all Australia's community pharmacies.
Major assumptions are :
(1) all national sales of Australia's community pharmacies are transferable to the respective public companies,
(2) the estimated above attributable proportions of sales to the supermarkets are appropriate, (3) the same 6.5% earnings can be transferred from community pharmacies to supermarkets to the added sales and (4) the market maintains the same P/E at current levels to the market capitalisation of the public companies.

Method 4 : in order to account for the greater efficiencies applicable by Coles and Woolworths to the above added pharmacy sales a notionally higher percentage of earnings is applied to these added sales .
The efficiencies are based on the reduction in costs and the increases in revenue from sales . The principal reductions in costs are
(1) rental and all outgoings ( including rates, taxes, security, promotion, etc), which for pharmacies and supermarkets in shopping centres of areas from 15,000 to 30,000 square metres may be assumed to differ by $400 per square metre (Johnston 2003) ,
(2) the reduction in area required in the supermarket pharmacy to accommodate the added goods and services in Method 3 transferred from the community pharmacy which may be assumed to be 100 square metres ,
(3) the reduction in staff required to operate the smaller supermarket pharmacy which may be assumed to be 0.5 fulltime equivalents of non-pharmacists and 0.25 FTE pharmacist, totalling $30,000 per annum and
(4) added pharmacy wholesaler and drug manufacture enhancements to those technologies now used in their 'supply chains'. That is, lower prices for medications and health-related products could be achieved for example if Woolworth's purchased the Mayne Group ( $2.76 billion on 24 October 2003) with both these activities or a far less costly Hallams pharmacy wholesalers or start their own wholesaler at even less cost ( Johnston 2003; Gallagher 2003) .
Supply chain improvements equivalent to savings of $10,000 yearly for a pharmacy with total sales pf $1,500,000 pa.

For enhancing revenue
(i) health-related services would be selected to include those with higher pro rata earnings and excluding those with lower pro rata earnings or denying those which like methadone dosing may be 'distasteful' to the desired image of supermarkets,
(ii) revenues would be further increased by offering fuel discounts and Fly Buys in combination with credit cards to attract new or retain old clients (Matterson, 2003) ,
(iii) efficiencies could be honed by carefully selecting locations and enhancing or enlarging pharmacies in prime heavy traffic locations and excluding locations serving small populations such as those in rural and remote areas and
(iv) profits or earnings could conceivably be raised by these savings and efficiencies to a notional 20% of the added pharmacy sales by implementing the above actions. The added earnings are assumed to be $17,500 pa for a pharmacy with total sales pf $1,500,000 pa.
The total savings and added profits are an estimated $97,500 pa for a pharmacy with total sales of $1,500,000 pa. The added earnings equate to an additional 6.5% pa or a total 13% earnings.
Accordingly, the higher proportional percentage earnings from 6.5% to 13% compensates for lower national pharmacy sales than those exemplified in Method 3. For example, the added value achievable by applying the increased notional 13% of earnings to 0.5 sales is estimated : 0.13 times of $7.07 x 0.5 billion x 19.2 or $8.8 billion to Woolworths ( P/E 19.2) and $13.9 billion to Coles Myer (P/E 30.2). These are speculative figures but may approximate the situation adjusted proportionally in the USA where non-pharmacist controlled supermarket and mass merchandiser pharmacies may represent nearly 50% of total pharmacy sales or similar to the examples of sales used in Method 4 for Coles and Woolworths.

Major assumptions are :
(1) 50% of the attributable national sales of Australia's community pharmacies are transferable to the respective public companies,
(2) the total savings and added profits equating to an added 6.5% making a total 13% of earnings are appropriate to the supermarket pharmacies and
(3) the market values the earnings and maintains the P/E at current levels to the market capitalisation of the public companies.

4.0 Conclusions
The following conclusions are based mainly on developments in Coles and Woolworths since 1980.
·* Woolworths and Coles have in two decades doubled their share of retail groceries and fresh foods to 77% of Australia's total and now are major players in the sales of many other products such as liquor, electronics goods and fuel
·* In total, Australia's community pharmacies achieve the maximum market capitalisation value when incorporated into a public company like Coles Myer or Woolworths or when grouped and valued at similar earnings multiples as public companies
* In total, Australia's community pharmacies remain at their lowest capitalised value when priced as individual pharmacies.
·* Woolworths and Coles are developing 'supply chain' efficiencies which produce very large savings in the purchase, storage, distribution and pricing of products
·* The products in community pharmacies may be amenable to the greater cost-efficiencies typical of large public industrial companies
·* Health services are becoming increasingly individualised and complex. Coles and Woolworths like most large public companies will resist individualisation in order to achieve the efficiencies obtainable with delivering standard products

List of References at this link
For an explanation of terminology used, click here

Declared interest: shares are held in Westfield Shopping Centre Group, Woolworths Ltd and Mayne Ltd
Con Berbatis
31 October 2003