Amid a consolidating market, a few Rx giants emerge
The strongest have survived. They’ve also gotten a lot bigger and more powerful.
Years of take-no-prisoners competition and withering profit margins at the pharmacy counter have severely winnowed the retail pharmacy playing field, and the attrition rate shows no sign of leveling off. The result has been the emergence of a handful of pharmacy giants with national reach and growing leverage in purchasing and managed care contracts—and increasing prescription market share for both drug store and mass merchandise chains.
The consolidation has been dramatic. A few powerhouse retailers have emerged as dominant players. Between them, the industry’s top two chains, Walgreen Co. and CVS Corp., control more than 30 percent of the nation’s retail pharmacy business, with combined prescription sales of more than $60 billion. Throw the No. 3, 4 and 5 players into the market-share equation—Rite Aid, Wal-Mart Stores and Kroger Co.—and together those five chains account for nearly half the nation’s retail pharmacy market.
The list of proud regional dynasties that have succumbed to the ruthless competition and/or merged with their larger counterparts could fill an industry directory, and that list continues to grow every year as the biggest retail operators wield ever-more-powerful economies of scale and outside threats like Medicaid reimbursement cuts add to the attrition rate.
Independent drug store operators are faring even worse in this new era of consolidation. After several years in which the independent pharmacy community staged a rebound, the past year has seen a major retreat in numbers.
More than 1,100 independently owned community pharmacies were sold or closed in 2006, according to Charlie Sewell, senior vice president of government affairs for the National Community Pharmacists Association. Citing a new report on independents from NCPA, he laid much of the blame on reimbursement foot-dragging by the prescription drug plans administering Medicare Part D drug benefits since the Part D program rolled out in January 2006.
“We’re losing an average of three independent pharmacies a day,” Sewell noted.
According to NCPA, the average net margin for owner-operated drug stores dropped 30 percent last year, from 3.7 percent to 2.6 percent. Those declines reverse a long period in which independent pharmacy appeared to regain its footing, with the industry rebounding to more than 24,000 stores nationwide in 2005. Since then, the number of indies has fallen to 23,000 or less, Sewell said.
“Both the independents and food stores are losing market share,” reported Meredith Adler, retail analyst for Lehman Brothers Equity Research. “We believe the independents will continue to lose share in the future as the costs and liquidity pressures caused by the shift of dual-eligibles to Medicare, combined with cuts to Medicaid, put great pressure on their profitability. This is likely to cause many to sell out to larger retailers.”
Hammered by the impact of mail-order competition, ever-tighter third-party reimbursements, federal cost-cutting initiatives and rising operating costs for pharmacists’ salaries, real estate and technology, pharmacy profitability remains on the endangered species list. As reported by Fortune and the National Association of Chain Drug Stores, net profit margins for food and drug stores average about 1.3 percent, compared with a Fortune 500 median margin of 5.2 percent.
Nevertheless, programs like Medicare Part D also have generated millions of new prescriptions for the nation’s pharmacies, as many of the nation’s roughly 44 million Medicare beneficiaries have signed up for benefits.
Prescriptions dispensed through Part D accounted for 17 percent of retail prescriptions by the end of 2006, according to IMS Health.
Top 30 Pharmacy Retailers ***
|Rank||Company||2006 Rx sales*||2006 total corp. sales*||% of sales from Rx||Total stores||No. stores w/Rx|
|1.||CVS Corp.**, Woonsocket, R.I.||$30,500||$43,800||70%||6,202||6,110|
|2.||Walgreens, Deerfield, Ill.||30,500||47,400||64||5,461||5,461|
|3.||Rite Aid†, Camp Hill, Pa.||18,400||27,500||67||5,192||5,192|
|5.||Wal-Mart, Bentonville, Ark.||12,700||226,300||6||3,443||3,314|
|8.||Safeway, Pleasanton, Calif.||3,700||40,200||8||1,761||1,350|
|9.||Supervalu, Eden Prairie, Minn.||3,100||38,000||8||2,449||943|
|10.||Longs, Walnut Creek, Calif.||2,600||5,100||50||509||509|
|11.||Sears Holdings, Hoffman Estates, Ill.||2,500||53,00||5||8,800||1,100|
|12.||Medicine Shoppe, St. Louis||2,500||2,600||97||1,384||1,384|
|13.||Ahold USA, Braintree, Mass.||2,200||22,400||10||795||639|
|15.||Albertsons LLC, Boise, Idaho||1,300||5,500||25||362||348|
|17.||Costco, Issaquah, Wash.||1,270||59,000||14||375||366|
|18.||Publix, Lakeland, Fla.||1,250||21,700||6||901||675|
|19.||Sam’s Club, Bentonville, Ark.||956||41,600||2||579||482|
|20.||H-E-B, San Antonio||920||12,600||7||305||198|
|21.||Giant Eagle, Pittsburgh||832||6,200||13||227||210|
|22.||Winn-Dixie, Jacksonville, Fla.||750||7,200||10||521||402|
|23.||Duane Reade, New York||736||1,600||47||248||248|
|24.||ShopKo, Green Bay, Wis.||662||2,200||22||135||134|
|25.||Wegmans, Rochester, N.Y.||563||4,100||14||71||71|
|26.||Freds, Memphis, Tenn.||563||1,800||32||701||289|
|27.||Kinney Drugs, Gouverneur, N.Y.||460||607||75||88||87|
|28.||Kerr Drug, Raleigh, N.C.||450||645||69||102||102|
|29.||Meijer, Grand Rapids, Mich.||435||14,700||8||176||176|
|30.||Pathmark, Carteret, N.J.||400||4,000||10||141||129|
|31.||USA/Super D, Pine Bluff, Ark.||330||600||55||150||150|
|32.||Sav-Mor, Novi, Mich.||323||390||82||85||85|
|33.||Aurora Pharmacy, Elm Grove, Wis.||304||312||97||134||126|
|35.||Discount Drug Mart, Medina, Ohio||290||605||48||66||66|
“Medicare Part D clearly was the most significant event to occur within the industry in 2006,” said Gerhard Gallwitz, vice president of managed care for IMS. “Consumers found the program especially beneficial because it offered greater choices and better access to medicines with fewer formulary restrictions than commercially available plans. For pharmaceutical manufacturers, Medicare Part D helped increase product demand through a larger pool of patients with prescription drug coverage.”
Prescriptions market share by retail channel
|Sales (billions)||Scripts (millions)|
|Sales at retail||% share of retail||% change||Sales at retail||% share of retail||% change|
|Total Retail Channel||$196.4||7.7%||3,420||4.3%|
|Chains (including Mass)||96.3||49.0%||9.1||1,946||56.9%||5.8|
Grocer sings new tune in community involvement
Meijer is taking another step in community relations, to the tune of promoting and selling CDs of local musicians.
The Michigan-based 176-unit grocery chain launched the Outside the Mainstream promotion in February with a solo CD from Josh Davis, a singer from Lansing, Mich., whose Fool Rooster CD was recognized by Performing Songwriter magazine for its lyric.
Each month, the chain is featuring a new performer in its circulars, which are sent weekly to 7 million households in Ohio, Michigan, Illinois, Indiana and Kentucky, according to company vice president of public affairs Stacie Behler. Meijer purchases 1,000 of the artist’s CDs and offers them for sale in all the chain’s stores for $7.49.
“The goal of the program is to bring some of the talent that we find in our own backyards to a wider audience than they can normally reach by themselves,” Behler said. “And by supporting this with a low price and a feature in our circular, hopefully it will lead people to gamble on the purchase of music that is worthy of discovery.”
Meijer, according to Behler, is trying to create regional loyalty to its stores by promoting local talent.
CDs chosen for promotion, according to the chain, must have a UPC and be professionally duplicated. Submitted CDs are sorted according to state and chosen on the basis of whatever state will be featured that month and how different the music is from the previous month.
Featured in April is Michigan-based Potato Moon with its CD “The Life of The Lonely Jones.”
CVS wins Caremark battles
WOONSOCKET, R.I. —The battle for Caremark Rx has finally come to an end. And, to the dismay of Express Scripts, CVS has emerged the winner, creating a $75 billion pharmacy benefit management powerhouse that is likely to serve as a benchmark for additional mergers within the industry.
“CVS/Caremark will offer end-to-end services, from plan design to prescription fulfillment, as well as the opportunity to improve clinical outcomes, which will result in better control over health care costs for employers and plan providers,” stated Tom Ryan, president and chief executive officer of CVS/Caremark, late last month when the deal closed. “The company will improve the delivery of pharmacy services and health care decision-making, enabling consumers to benefit from unparalleled access, greater convenience and more choice.”
With the close of the transaction—ultimately valued at $27 billion—CVS/Caremark has moved into a strong, competitive position. The combined company will be No. 1 in pharmacy sales, PBM-managed lives, specialty pharmacy sales and retail-based health clinics. It will be No. 2 in mail services.
That adds up to a lot of extra leverage for the retail health care juggernaut with suppliers, as well as insurers and payers.
In terms of synergies, CVS expects to realize between $800 million to $1 billion in revenue synergies in 2008, and significantly more thereafter. The company expects about $500 million in cost savings, largely related to better purchasing.
“We would like to note that every deal that both CVS and Caremark have done historically has yielded synergies significantly in excess of original guidance,” stated Citigroup analyst Deborah Weinswig in a recent research note. “We believe this deal will be no exception.”
Charles Boorady, also of Citigroup, believes that if the company achieves cost savings from the drug-procurement process, it likely will come from a combination of the following: manufacturers accepting the lower price or offering greater rebates, the wholesalers and distributors accepting lower prices and manufacturers bypassing the wholesalers and selling directly to the combined CVS/Caremark entity.
While many industry observers view the merger as a boon for the companies, it undoubtedly will have major implications on the industry, in general, as vertical integration is a new paradigm that—if successful—could clear the way for more mergers moving forward, with Medco and Express Scripts likely being the next targets.
“The fragmentation in the past may be the reason why vertical integration did not work, but the sheer scale of the CVS/Caremark company may be able to make it work,” Boorady said. “The only test will be whether customers buy into the concept or the concerns over the perceived channel conflict will outweigh it.”
Either way, Boorady sees it as a win-win for rival PBMs. “I see Medco and Express Scripts winning either way. If this integration works, they are likely to be the ones that are acquired next. If it doesn’t work then they could stand to gain customers that prefer a standalone [PBM] instead of a vertically integrated model.”
Another issue such a deal brings to the forefront is network restriction. If customers are willing to restrict the retail pharmacy so that employees can get their prescriptions filled at a single chain, or just a few chains in the market, then it will make the synergy from a vertical integration more obvious, according to Boorady.
However, this has been a concern for several years and has yet to materialize.
“I think most employers have concluded, and will continue to conclude, that the sheer hassle factor that you are putting on your employees by making them go to a CVS instead of a Walgreens, or vice versa, isn’t really worth what little savings you can get relative to other things you can do that present less of a hassle to the employee but can save a lot more money,” Boorady said.
However, prior to the deal, CVS Pharmacare controlled a provider network of more than 56,000 retail pharmacies. Meanwhile, Caremark’s network numbered more than 60,000 retail pharmacies, so it is unlikely that the combined company, post-merger, would suddenly pull back the size of its network—particularly, if the end goal is to remain attractive to insurers and payers and competitive with stand-alone PBMs.
According to William Blair & Co. analyst Mark Miller, the combined company is facing its first big test as it expects an announcement on the large Federal Employee Program contract—currently up for negotiation—as early as May. Three years ago, Caremark won this contract from Medco and it is likely that the two PBMs, among others, will bid for this business aggressively.
“While there are many moving parts to these types of negotiations, this will be the first big test for the new CVS/Caremark, and may provide some incremental perspective on the current state of the competitive environment,” Miller stated in a research note.
In related news, CVS/Caremark has announced the members of the company’s board of directors. As previously disclosed, the 14-member board was evenly split among designees from CVS and Caremark.
Former Caremark chairman and chief executive officer Mac Crawford has been elected chairman of the board of the combined company. Ryan will continue to serve as president and chief executive officer.
The following individuals named to the board from CVS are:
Ryan, president and chief executive officer of CVS/Caremark Corp.
David W. Dorman, senior advisor and partner, Warburg Pincus LLC.
Marian L. Heard, president and chief executive officer, Oxen Hill Partners.
William H. Joyce, chairman and chief executive officer, Nalco Co.
Terrence Murray, former chairman and chief executive officer, FleetBoston Financial Corp.
Sheli Z. Rosenberg, former vice chairman, president and chief executive officer, Equity Group Investments LLC.
Richard J. Swift, former chairman, president and chief executive officer, Foster Wheeler Ltd.
The following individuals named to the board from Caremark are:
Mac Crawford, chairman of CVS/Caremark Corp.
Edwin M. Banks, founder, Washington Corner Capital Management LLC.
C. David Brown II, chairman, Broad and Cassel.
Kristen E. Gibney Williams, former executive of Caremark’s Prescription Benefits Management division.
Roger L. Headrick, managing general partner, HMCH Ventures; president and chief executive officer, ProtaTek International
Jean-Pierre Millon, former president and chief executive officer, PCS Health Systems
C.A. Lance Piccolo, chief executive officer of HealthPic Consultants