New rules and price caps for generic drugs mean the pain has already started. But more restrictions are on the way, and things will get tougher if smaller provinces match the low payments enforced by Ontario and Quebec.

"This is going to be ongoing, I think, probably for the next half decade or more," said Duncan Sinclair, a health policy expert and former dean of medicine at Queen's University in Kingston, Ontario.

Under Canada's taxpayer-funded medical system, provincial governments spend billions of dollars a year on drug programs for the elderly and people with low incomes or particularly high costs.

Cutting drug costs will help governments tackle deficits, and top chain Shoppers Drug Mart Corp and Quebec rival Jean Coutu Group Inc say the changes are already weighing on sales and margins, though they have not given precise figures.

Shoppers' same-store prescription sales rose just 0.6 percent last year, after climbing more than 5 percent, at times more than 10 percent, every year from the company's 2001 initial public offering to 2009.

Ontario and Quebec now cap prices for most generic drugs at 25 percent of their branded equivalent, while Ontario is phasing in a ban on some payments from drug companies to pharmacies.

British Columbia wants to match Ontario's 25 percent cap next year, and others may follow. Some regulations link prices in the private market to those paid by the public sector.

Moving further ahead, leaders of Canada's provinces and territories said in July they would team up to launch a competitive bidding process to cut prices for three to five top generics. More details are expected this fall.

And Ontario is targeting some of the highest-volume generics for further price cuts.

"Hospital budgets, physician fees, things of that nature are certainly larger than the drug budget, but it is a politically palatable target," said Steve Wilton, a vice president at the Canadian Association of Chain Drug Stores.

ADVERSE EFFECTS

Canada has a reputation for relatively low prices for branded prescription drugs, and dozens of websites promise cheap Canadian drugs to U.S. customers. But a flurry of studies in the mid-2000s found that generic drug prices in Canada were unusually high.

When Deb Matthews, Ontario's minister of health, took office in 2009, staff showed her data on the price gap. A table from around that time shows Ontario was paying 5.6 times more than patients in the United States for generic Zantac, prescribed for acid reflux, and 2.6 times more for the epilepsy drug gabapentin.

"I have to say, when I saw it, I thought it wasn't comparing apples to apples. It didn't make sense to me," Matthews said. "But it turned out to be absolutely true."

Patented drugs are expensive because their producers enjoy a short-term monopoly. Generic drugs, which can be supplied by a number of companies, are less expensive, although Canada's Competition Bureau argued in 2007 that most of the savings were going to pharmacies, not patients or payers.

This was because suppliers offered pharmacies incentive payments in the form of rebates or "professional allowances" as they competed for shelf space. Pharmacies had little reason to pass on those savings, because patients, often covered by insurance, rarely shopped around.

The Competition Bureau cited research estimating that if Canadian generic prices were brought in line with international medians, spending on generics could fall by almost a third.

Shoppers is challenging one part of Ontario's reforms in court, arguing that it should be allowed to sell private-label generic drugs despite a lower court's ruling that they circumvent the province's bans on rebates and professional allowances.

Ontario won that case at Ontario's Court of Appeal last December, and it is now before the Supreme Court of Canada. A win could let Shoppers recover some of the earnings it lost to the end of rebates and allowances in Ontario.

To be sure, it's not all bad news for the pharmacies. Payments for new services promised by several provinces along with their price cuts, such as modifying prescriptions and giving injections, could boost earnings over the long term.

Major players may also benefit from consolidation as the new rules hit smaller pharmacies hard. On a conference call in July, Shoppers' Chief Financial Officer Brad Lukow said a number of deals were in the pipeline.

Edward Jones analyst Brian Yarbrough expects other provinces to bring prices down to Ontario levels, but said that future regulatory changes will not likely hit Shoppers as hard as did the cuts in Ontario, its biggest market.

"The biggest impact will be behind them once professional allowances are eliminated, because that was a big profit driver," he said.

Much of Jean Coutu's business is in Quebec, where prices are already in line with Ontario's.

But in the short run, Ontario has said it will cut prices for the top 10 drugs once again, to 20 percent.

"We know there is still some room to do more," Matthews said. "We know that there are some high-volume drugs where there are some pretty high profit margins."

(Additional reporting by Claire Sibonney; Editing by Janet Guttsman and Frank McGurty)

• A Permanent Economic Emergency