OBJECTIVES: Pharmaceutical expenditure is rapidly growing and accounts for 40-50 percent of total medical care expenditures. In order to contain drug expenditure growth effectively, we need to understand what the drivers are. This study aims to answer the question by decomposing the pharmaceutical expenditure changes into prices, volume, and product substitution effects. METHODS: By using quarterly drug sales records from 2006-2011 of a large public hospital in Sichuan province, we analyze the pharmaceutical expenditure changes for two therapeutic groups: antibiotics (249 products molecules with 2491 records) and cardiovascular(130 products molecules with1668 records). After standardizing volume and price recommended by DDD (WHO), a statistic index factor analysis is employed. Specifically, Laspeyres price index (LPI) and chained LPI are employed to calculate the price changes with and without entry and exit of products over time. We also take a closer look at the substitution pattern, including shift among therapeutic groups, shift between brand and generic drugs, and shift between old and new drugs. RESULTS: Our results show that both antibiotics and cardiovascular drug expenditures increased over 30% in the past 5 years. Interestingly, prices are continuously dropping and the volumes are slightly increasing for both antibiotics and cardiovascular drugs. Relatively speaking, substitution effect plays the most important role in expenditure growth. Specifically, proportions of brand-name drugs, new drugs, and more therapeutic advanced drugs are increasing over time. CONCLUSIONS: Our study indicates that the key factor that contributes to the expenditure growth is product substitution effect. Thus, price control policies may not be an effective way to control the rapid pharmaceutical expenditure growth. Instead, more attention should be paid on how to control the substitution shifts, which may be caused by prescriber behavior and consumer demand. Further analysis should also be on the impact of substitution shift on quality of health care.