Industry mulls deep discount's future; Phar-Mor scandal tops list of troubles plaguing off-pricers

Drug Store News, Sept 7, 1992 by James Frederick

Phar-Mor scandal tops list of troubles plaguing off-pricers

Is deep discounting for real?

The Phar-Mor juggernaut has derailed. Drug Emporium is awash in red ink. Of the Big Three of deep discount drug retailing, only the smallest, F&M, is currently making money. Another off-pricer, Dot Drug Stores, went out of business early this year, less than two years after Wal-Mart concluded the concept wasn't worth its time and sold Dot to a small group of owner-operators.

In the wake of massive allegations of fraud, a $350 million write-down and a bankruptcy filing, the very survival of Phar-Mor remains an open question. One thing the scandal involving former officers Michael Monus, Patrick Finn and others immediately revealed: the chain didn't actually turn a profit last year or the have made any money.

Phar-Mor's lack of profitability stems from several factors, including what spokesperson Carol Robinson said was a lack of accurate information. "The company could have been profitable all along," she argued, "if management had had the right tools with which to make decisions."

But instead of cultivating profits over the last decade, the chain has specialized in blitzkreig growth tactics, tough negotiating with vendors and huge stores whose ever-increasing size demanded huge quantities of product and prices that were often so low that they guaranteed the company would lose money in many categories. If nothing else, the chain's problems demonstrate the difficulty of turning a profit on the below-20-percent margins that are deep discounting's strongest suit.

Robinson says the chain's basic concept remains extremely viable, and from a customer's point of view, that's absolutely true. Even taking into account the newest units, Phar-Mor stores average roughly $10 million in annual sales. More than four-and-a-half million customers come through the doors every week, according to the company. Across the U.S., "Power Buying" is now a well-known metaphor for consistent low prices and broad selection. In less than a decade, Phar-Mor has reached upward of $3 billion in annual sales.

But it remains to be seen whether the chain can adopt the kinds of disciplines and controls that will allow it to squeeze a profit, however slim, from that massive revenue stream. Those controls require a total overhaul of the company's way of doing business - including its merchandise mix, its store location criteria, its support structure, advertising, inventory levels, warehouse operations and accounting.

Beyond that, those controls require more accurate and up-to-date information on sales and inventory flow. That information requires more technology, and technology costs money. It isn't clear where that money may come from.

Drug Emporium

Drug Emporium's problems are less dramatic, but they reflect some of the same underlying challenges posed by the special constraints of deep discounting. Problems include being squeezed by intensive competition for the HBA business, shrinking margins that are already razor-thin and high overhead throughout its far-flung store network. The chain lost $4.7 million in fiscal 1992 and another $710,000 in the most recent quarter.

Ceo Cary Wilber ticked off the problems faced by Drug Emporium and other deep discounters earlier this summer: consolidation of the competition into "everstronger players," low price inflation, low near-term unit growth in sales and a HBA market that's under assault from a host of competitors.

Drug Emporium is fighting back with a full restructuring of its operations, aggressive cost-cutting efforts and the centralization of buying, marketing and accounting. More recently, the company has begun a complete scrutiny of its merchandise mix, retail format and purchasing patterns in an effort to cut inventory levels and maximize store space.

The recent efforts by both companies are praiseworthy and long overdue. But they also underscore fundamental questions about the deep discount drug store industry itself. It is, after all, a business rooted in aggressive dealmaking, forward buying in huge volumes, entrepreneurism and decentralized management. Decisions about merchandising were often as firmly wedded to intuition as to science. Technology and information were often back-burner issues. But in this era of super-efficient, technology-driven operators like WalMart, Walgreens and Smith's Food & Drug, those values are no longer enough to allow larger off-price retail chains to survive.

"The real question is, does the concept really work or not?" noted one Phar-Mor supplier, who asked not to be named. "A lot of people have questions about the viability of the industry."

Added retail analyst David Magee of The Robinson-Humphrey Co., "We began to be more negative on the [deep discount] concept long before the problems with Phar-Mor surfaced.

"The problem is that well-run, traditional drug store chains are more of a competitor to the deep discounters than they used to be, especially as more and more Americans rely on third-party-payment plans for the drugs. The cost savings are no longer a big factor, and customers can get their scripts more conveniently at a traditional drug store," said Magee. "Also, deep discounters have found themselves competing more and more with well-run, low-cost discounter operators like Wal-Mart, Kmart and Target . . . which have much better control over their inventory and pricing structure."