CHICAGO -- As national health care undergoes reorganization, chain drug retailers are struggling to remain competitive. Survival will depend upon chain drug's ability to harness its inherent resources and fully integrate into the emerging health-care system, according to a J.P. Morgan analyst.
The realities of what chain drug retailers face in today's marketplace were driven home by Mark Husson, vice president at J.P. Morgan Securities, New York, during a presentation at the Alexandria, Va.-based National Association of Chain Drug Stores' Pharmacy Conference, held here last month.
According to Husson, chain drug stores are losing out at the front end due to price competition from alternative channels, and health and beauty care volume that is being driven by supermarkets, mass merchandisers and supercenters. "The more of this that goes on [square footage expansion by alternative formats], the greater the pantry loading in health and beauty care products, which is the bread and butter of drug stores' front end," said Husson.
Husson predicted further drug store market-share erosion at the front end if drug retails remain at 10% or more above the competition. Yet, as drug retailers are forced to lower their front-end prices their profitability will suffer further erosion.
What is sustaining chain drug profitability today is the $89 billion prescription drug business, of which chain pharmacy represents 24.6% of the market, followed by drugs dispensed from hospitals, 21.9%; independent pharmacies, 19.7%; mass merchants, 7.4% and supermarkets, 7%. The remainder of the pharmaceutical market, or 19.4%, is represented by drugs dispensed through nursing homes, mail order, home health, health maintenance organizations and clinics, among others.
Back-end sales growth is maintaining gross profit at about 8% despite lower gross margins, according to J.P. Morgan's Drugstore Industry Analysis, published Aug. 24.
But as Husson illustrated, back-end gross margins also are being squeezed because of the penetration into chain drugs by low-margin third parties. Third-party payers now represent 51% of total retail prescription sales. This is expected to grow to 80% by the end of the decade, according to the J.P. Morgan report. "Chain drug retailing is a prescription-driven business where drug stores' remuneration and profitability increasingly are out of the retailers' control and in the hands of third-party players," Husson said, and asked whether this is good for the industry over the long term.
"Unless drug retailers develop some pricing power in this system, it could be very bad," he commented.
One positive trend that bodes well for the industry is the increasing number of aging baby boomers. By the year 2010, 70.8 million Americans will be over age 55 and demanding pharmaceutical products. Husson suggested that chain drug retailers can better position themselves for the future and strengthen front-end profitability by changing the product mix to better meet customer needs for healthy products and by offering more profitable private-label choices.
He suggested drug retailers move from convenience items such as tobacco and liquor, which now represent about 10% of a retailer's front-end sales, to more healthy selections such as reduced-calorie and low-fat foods, and natural, Body Shop types of toiletries.
"Why are there no extended natural collections of bath and body products featuring the caring, healthful retailers' brand? Why have drug store retailers been so poor with private brands when there are all those wonderful associations with herbs and apothecaries?" Husson asked.
To maintain the profitability of their back end, chain drug retailers such as American Drug, Eckerd, Revco and Walgreen have begun to venture into the mail order business to be more price competitive in the prescription drug arena. Husson predicted that Kroger would soon attach a mail order business to its central Peyton HBC purchasing and distribution business.
Retailer-owned pharmacy benefit management also has become a natural adjunct to drug chain retailing and offers important opportunities in disease management. The ultimate goal for chain drug retailers is to move from drug dispensing to "managing information on health in an integrated and systematic way," said Husson.
"For the retailer to be important in this whole process, they need to consolidate their prescription business into an efficient machine and then integrate it back into the rest of the whole health-care industry," Husson explained.
Prior to Husson's presentation, David Maher, president and chief operating officer of American Stores Co., Salt Lake City, who is also this year's NACDS chairman, confirmed chain drugs' direction by saying, "Information is becoming the life thread of our industry and we must push forward with the technological developments so we can provide that kind of information . . . Terms like vertical integration, disease state management, outcomes management need to be defined and understood so that we as an industry can position our retail pharmacy entity as a viable cost-effective store." This year's conference, Aug. 27 to 30, drew a record attendance of about 1,500 retailers, educators, pharmacists and drug companies. Of the 87 retailers in attendance, about 25 were supermarkets.
