Script for expansion: Increasing control, boosting business

The biggest pharmacy chains' interest in retail clinics is only part of a strategy to branch out or expand into other ventures to become one-stop health shops.

By Bob Cook — Posted Aug. 27, 2007

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As the local independent pharmacy once gave way to the mega-colossal drugstore chain, the mega-colossal drugstore chain is now giving way to the self-described "health care company" -- one that is shaking up the genteel physician-pharmacy relationship.

Chains such as CVS Caremark and Walgreens are expanding into pharmacy benefit management, specialty pharmacies, mail-order distribution. They look for anything that can increase control, store traffic and negotiating leverage in a business that on one side faces intense price and convenience competition from grocery and big-box retailers, and on the other, risks being squeezed by third-party payers.

Their interest in retail clinics -- in the case of CVS Caremark and Walgreens, an interest that led each to buy clinic chains -- is but one part of an overall business strategy. They are seeking to provide convenience to patients, who can meet their everyday health needs at one location, and employers, who can contract through the drug chains to pay less for drugs and some services.

But do pharmacy chains see themselves as competing with doctors, like the chains might compete with the likes of Wal-Mart? "The short answer is no," said Chris Bodine, president of CVS Caremark Health Care Services, the division that oversees its MinuteClinic in-store clinics. "We wouldn't get into a business that we thought was competing with our physicians."

But that's not how physicians necessarily see it. The AMA House of Delegates in June adopted policy that called for state and federal investigations into possible conflicts of interest between clinics and the pharmacies that own or host them. The new policy also opposes special treatment that might give traditional practices a competitive disadvantage, such as waiving regulations for clinics that do not otherwise comply with standards for medical facilities, and insurers reducing or lowering co-pays to encourage in-store clinic use.

Some delegates wanted all-out opposition. For example, the American Academy of Pediatrics "strongly discourages" use of retail clinics because they are not a "medical home."

AMA Board Chair Edward L. Langston, MD, a Lafayette, Ind., family physician, said doctors' beefs aren't with pharmacists -- Dr. Langston himself being one. In fact, he said, doctors and pharmacists are both seeing time with patients squeezed. What's going on, he said, is big business trying to maximize its revenue.

"We're seeing a consolidation of an industry, then that industry starts looking for other sources of income and cash flow, and we've seen the evolution into the retail clinics that are coming in pharmacies and some other arenas," he said. As for pharmacy benefit management and similar pushes, "I look at it as big business moving into another business arena that then does have impact on patients and distribution of medications."

With large chains subject to reimbursement pressures and delays, "they are caught in similar dynamics" as anyone else in health care who relies on third-party payment, Dr. Langston said. Except that they have the size, scope and cash flow to adjust their strategy, instead of dying out like most independent pharmacies, he said.

Consolidated, yet fragmented

It would appear that among pharmacy chains, consolidation is almost over. Woonsocket, R.I.-based CVS Caremark has amassed about 6,200 stores, most notably through a strategy of buying large chains such as Revco, and regional chunks of such chains as Eckerd. Deerfield, Ill.-based Walgreens has grown to about 5,800 stores, mostly through new locations, though it has bought smaller chains to fill in regional gaps.

Camp Hill, Pa.-based Rite Aid has more than 5,000 stores, recently boosting its total by buying the Brooks Pharmacy chain and the Eckerd locations CVS didn't buy. The fourth-largest publicly traded chain, Longs Drugs of Walnut Creek, Calif., has 500 stores.

CVS Caremark and Walgreens are aggressively opening more stores. But despite appearing dominant, they are competing in a fragmented retail industry, said Adam J. Fein, PhD, president of Philadelphia-based Pembroke Consulting, a pharmacy supply chain research and consulting firm. Pharmacy chains represent 40% of all prescriptions filled, he said. The rest go through grocery or department store pharmacies or mail-order businesses.

Meanwhile, the biggest chains are heavily dependent on third-party payments. CVS Caremark, Walgreens and Rite Aid all report, in their latest quarterly filings, that about 65% of their revenue comes from prescriptions. And about 95% of that comes from third-party payers. That's why the big chains didn't lower generic prices when Wal-Mart, Target and K Mart did, analysts say -- they're just not as dependent on cash-paying patients.

Still, the big chains are feeling pricing pressure from public and private insurers, analysts say. The National Council of State Legislatures reports that at least five states have launched Web sites that let patients compare drug prices across pharmacies.

So CVS Caremark and Walgreens -- though not Rite Aid, which by its own admission has a comparatively heavy debt load -- have used acquisitions to bolster businesses that would either capture a larger share of pharmacy sales or funnel customers to their stores.

Earlier this year, CVS Corp. made the splashiest deal, paying $26 billion for Caremark, a pharmacy benefit management company that also operates the fifth-largest mail-order pharmacy business. CVS engaged in a months-long battle for the company with ExpressScripts, an independent PBM, and ended up paying $5 billion more than its original bid of $21 billion. CVS already had a PBM, but the deal made the new CVS Caremark one of the largest and most influential players in that business.

In June, Walgreens announced it would pay $850 million for OptionCare, which offers specialty pharmacy and home infusion services. CVS Caremark and Walgreens both have expanded their specialty pharmacy businesses, which are retail outlets that provide drugs for rarer or chronic conditions and that tend not to have generic equivalents.

Meanwhile, Walgreens has elected not to expand its PBM operations through acquisitions. The company did not make available anyone for an interview with American Medical News.

The big drug chains' recent acquisitions are a direct result of their domination of the stand-alone pharmacy business, said Arthur C. Sturm Jr., president and CEO of SRK, a Chicago-based health marketing company.

"It's pretty smart for retailers to look at these other areas, because they're natural extensions of these core businesses of providing medications," Sturm said. "They have the scale and distribution to get into narrower lines. But when it's rolled up nationally, it becomes a significant piece of business. Scale is paying off for these guys."

How in-store clinics fit in

The retail clinics, analyst say, are the bow on the chains' package. As Dr. Fein explains it, the chain stores are trying to accomplish four goals: gain more control within the pharmaceutical industry, utilize floor space effectively, aggressively compete with supermarkets and big-box retailer pharmacies, and leverage their brand names.

The in-store clinics, he said, accomplish all four goals, giving chains a means to direct patients to the pharmacy and burnish the reputation they seek as health centers.

The fact that CVS Caremark, which bought MinuteClinic last year, and Walgreens, which earlier this year bought TakeCare Health Systems, own their own clinics is wise, he said. In most cases, in-store clinics are controlled by a company that rents space within a pharmacy.

"One of the advantages of owning an asset versus renting on the market is you can control how that company behaves," Dr. Fein said. "I also think when you're giving a third party space in your store, it's a risk. What if the third party decides it should get paid 20 times as much, or that it should not pay CVS for the space?"

Dr. Fein also said he believes that pharmacies don't want to compete against physicians. CVS' Bodine notes that in his clinics' case, about 30% to 35% of patients don't have a physician, and 80% to 85% of visitors only come once a year.

But pharmacy chains and physicians are butting heads. In Massachusetts, medical societies have petitioned the state not to approve waivers in regulations that CVS Caremark said didn't apply to its limited-service clinic model. On July 17, the state's health department announced it would issue new regulations for retail clinics and said it hoped those regulations might encourage nonprofit hospitals, community health centers and businesses to expand delivery of basic health services.

Jesse Vivian, a professor of pharmacy practice at Wayne State University in Detroit, said the complicated regulatory environment might make CVS Caremark and Walgreens think buying a clinic chain is more trouble than it is worth.

But whether drug chains buy companies or lease space, whether they are buying a specialty pharmacy or a PBM, he hopes the pharmacy companies think of the patient's needs first -- the same statement much of organized medicine has made.

The drug chains maintain they are doing just that.

"Having the objectivity of not being swayed or biased by whoever owns the practice, and the ability to make unfettered decisions for the best interest of the patient -- that's a model I hope we can hold onto in this country," Vivian said.

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Acquired taste

[download pdf]
CVS Caremark and Walgreens, the nation's largest pharmacy chains, have expanded into such businesses as pharmacy benefits management, specialty pharmacies and retail clinics. CVS generally has done the bigger, splashier deals, while Walgreens, until recently, had little interest in acquisitions. But Walgreens is the more frequent dealmaker these days, although Option Care, its largest-ever -- by far -- deal, wouldn't make CVS' all-time top five. The companies' recent deals are shown in the pdf.

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Outside influence

Drugstore chains and physician practices have one commonality: They know what it's like to rely on someone other than the patient to pay the bill. Particularly with the introduction of Medicare Part D, pharmacies say they're vulnerable to the whims of government and insurance, which is why chains are diversifying into businesses beyond filling scripts. Here is a breakdown of pharmaceutical revenue, as of the largest drugstore chains' latest quarterly filings:

2007 prescription sales
Chain Stores Revenue Paid by third party
CVS/Caremark 6,200 69.7% 94.4%
Walgreens 5,800 65.9% 94.8%
Rite Aid 5,100 64.4% 95.7%
Longs Drugs 500 52.4% 95.0%

Notes: CVS totals affected by merger with Caremark, a pharmacy benefits management company. Longs Drugs data for retail locations only. Does not account for RxAmerica, company's PBM.

Source: Company Securities and Exchange commission filings

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If they can open retail clinics...

With drugstores opening retail clinics, it might seem one way for physicians to fight back is to open a pharmacy, or maybe just get rights to dispense drugs in the office.

But that's also a way to quickly realize why it's so difficult to find a small, independent drugstore anymore, says Jesse Vivian, an attorney and professor of pharmacy practice at Wayne State University in Detroit. Not only do physician-run pharmacies or office dispensing services have to follow a litany of state regulations, but there is also the danger that they could be considered in violation of federal anti-referral and anti-kickback rules as well.

The bottom line: There's not much chance in a positive bottom line in running a small pharmacy.

"The economy of scale is so small on pharmacy dispensing that I think most physicians would recognize that by the time they set up the kind of record-keeping they need to do, the inventories they would need to keep, the amount of profit they would make on it is prohibitively small," Vivian said.

However, that doesn't mean physicians should never get into the pharmacy business, he and other experts said. Indeed many did long before the idea of retail clinics was even imagined.

You might have a patient base that would appreciate the convenience of a pharmacy in your medical office building, or being able to pick up their prescriptions in your office.

The AMA's Code of Ethics says physicians may own or operate a pharmacy, but generally may not refer patients there. It also says that physicians may dispense drugs in their office "provided such dispensing primarily benefits the patient."

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