Drug store leaders look to promise beyond industry pitfalls of today

Drug Store News, April 28, 2003 by James Frederick

Fighting for every dollar.

That could sum up the state of chain drug retailing after three years of economic retreat, a halting recovery, faltering consumer confidence and seemingly endless waves of wrenching job losses for millions of Americans. And even with the apparent rapid success of U.S. forces in the war in Iraq, a real pickup in factory orders, new jobs and consumer demand is unlikely until other long-term economic issues are also dealt with.

It isn't pretty, but it's the reality that pharmacy retailers from all channels--chain and independent drug stores, discount mass merchandisers and supermarkets--are grappling with as they work to cut operating costs to the bone and position themselves for the eventual upturn. Even the most upbeat and confident retail executives express caution.

"The sluggish economy requires that we take the necessary actions to tightly control our costs of operation and capital spending," noted Duane Reade chairman, president and chief executive officer Tony Cuti earlier this year, echoing the industry's consensus.

There remains no shortage of other potholes on the road to a healthier drug store industry in 2003. Besides the continuing assault on prescription dispensing margins at the hands of public and private managed-care plans, chain and independent drug store operators also are faced with intensifying competition for both their pharmacy and front-end business.

That competition certainly is coming from Wal-Mart Stores, which has become one of the nation's biggest-selling prescription retailers with pharmacy counters in nearly 3,000 of its stores. But it's also coming from other mass merchants and from supermarkets. And, perhaps most alarmingly, it's coming increasingly from mail order pharmacies.

According to IMS Health, mail order and mass merchandise pharmacies are the fastest-growing outlets for prescription sales. Total retail sales of prescription drugs rose 11.3 percent in 2002 to $182.7 billion, IMS reported. And while traditional chain drug stores still accounted for the largest share of that total, with $73.4 billion in sales and 40.1 percent of the total market last year, their 8.4 percent growth rate was eclipsed by mail order pharmacy, whose sales rose 21.7 percent to $33.5 billion. Also outpacing chain drug pharmacy sales gains were mass merchandisers, whose share rose 14.3 percent to $17.4 billion, and supermarkets, with a prescription sales gain of 9.9 percent to 21.8 percent. Independents managed a gain of 8.2 percent to $36.8 billion, or 20.2 percent of the retail prescription business.

For traditional drug store chains and independents, "We think the most significant near-term issues are softer sales due to market share loss to other channels and a generally weaker economy, as well as increased competition," noted Lisa Cartwright, a retail analyst with Salomon Smith Barney.

Besides mail order and other legitimate channels, that competition is now coming from outside the United States. Rapid startup storefront pharmacies that offer cut-rate imported medicines from Canada and other countries have become an increasing headache for U.S. retailers, and are drawing increasing scrutiny from the Food and Drug Administration.

In addition, drug retailers in all trade channels are faced with the prospect of a deepening fiscal crisis in the states, nearly all of which are struggling with rising costs for Medicaid and 'declining tax revenues. Cuts in reimbursements for Medicaid prescriptions are likely to remain a favorite tool of cash-strapped states this year and are likely to spark more revolts among chain and in a ependent drug stores as they did last year in Delaware and Massachusetts.

"States are in their worst fiscal crisis since World War II ... and over the last several years they have seen their Medicaid costs rise substantially," said Chris Jennings, who served as senior health policy advisor in the Clinton White House and now is president of Jennings Policy Strategies.

Also looming is the prospect for Medicare reform and a drug benefit for seniors. Public and private-sector third party payers now account for nearly 9-of-every-10 prescriptions filled by chain pharmacies, leading to unparalleled influence over drug utilization rates, drug formularies, generic substitution rates and the profit margins pharmacy retailers can still squeeze out of the prescription dispensing business. And with nearly all Medicare reform proposals that have surfaced in Congress or the White House envisioning a big role for prescription benefit managers in the administering of any drug benefit for seniors, the power PBMs have over community pharmacy is only likely to increase.

Chain and independent pharmacy will remain on the front lines of the battle to shape Medicare reform legislation. "Ultimately, I think we're going to have some form of Medicare prescription coverage, and we are committed to finding ways to do that," said Craig Fuller, president and chief executive officer of the National Association of Chain Drug Stores. But he said real reform of Medicare could be "extraordinarily difficult" this year, with a drug benefit package for seniors competing with the costs of war in Iraq, budgetary crises in the states, continuing economic turmoil and a massive tax cut proposal all competing for the attention of lawmakers.