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The widespread availability of Walgreens and CVS Health stores makes them a go-to choice for individuals like Shriya Raghavan, a research associate in Philadelphia, who looks for everyday items like gum, deodorant, and soap. However, Raghavan often finds herself waiting for employees to unlock secured products or standing in long lines for prescriptions, highlighting customer frustrations with staffing and service delays.
This dissatisfaction is part of a broader trend affecting the retail pharmacy industry, leading to declining profits and falling stock prices for both Walgreens and CVS. Retail pharmacies are reassessing their business strategies in light of these challenges, which have prompted them to move away from aggressive expansion and instead close numerous locations across the United States in an effort to stabilize financial performance.
Over the past decade, both CVS and Walgreens have seen a significant decrease in stock value, with CVS performing slightly better. Key challenges for these chains include decreasing reimbursement rates for prescription drugs, inflation, reduced consumer spending, theft, and competition from online retailers such as Amazon and traditional grocery stores. These factors complicate the already difficult balancing act of maintaining profitability in retail, where profits are being squeezed in non-pharmacy goods and services.
Another critical issue is the burnout experienced by pharmacy staff, many of whom cite high workloads and staffing shortages. Although CVS and Walgreens benefited from increased demand during the COVID-19 pandemic through vaccinations and testing sales, the return to pre-pandemic conditions has brought forgotten hurdles back into focus. Analyst Brian Tanquilut from Jefferies remarked that the challenges facing the retail pharmacy sector existed prior to the pandemic, and many pharmacies are now grappling with the realization that their fundamental operational models remain unchanged.
The profitability of retail pharmacy operations is under increased strain from declining margins. Walgreens is currently navigating challenges with its venture into primary healthcare, while CVS has reported rising costs in its insurance division. This month, CVS downgraded its profit forecast for the third consecutive quarter, indicating that the pressures from higher healthcare costs are impacting profitability. Other competitors, such as Rite Aid, have faced even more severe consequences, filing for bankruptcy and shuttering numerous locations.
Wall Street’s reaction has been pessimistic, with Walgreens’ stock plunging nearly 60% this year alone and approximately 80% over the preceding decade. CVS has seen its shares decline roughly 30% in both the last year and the past ten years, while Rite Aid’s shares were delisted from the New York Stock Exchange in October.
Despite the current challenges, retail pharmacy chains like CVS and Walgreens are integral to the U.S. healthcare system, serving the needs of millions of Americans. However, a transformation may be necessary. Neil Saunders, managing director at GlobalData, indicated that pharmacy chains are reevaluating their business models to meet evolving consumer demands amidst changing economics.
Falling Pharmacy Reimbursement Rates
The decline in profitability is largely linked to reduced prescription reimbursement rates. Pharmacies source medications from distributors and receive reimbursements from pharmacy benefit managers (PBMs). These intermediaries negotiate discounts with manufacturers on behalf of insurers and manage lists of covered medications for health plans.
The largest three PBMs – CVS Health’s Caremark, UnitedHealth Group’s OptumRx, and Cigna’s Express Scripts – account for nearly 80% of U.S. prescriptions. Retail pharmacies have criticized PBMs for enforcing lower reimbursement rates, at times compensating them less than the actual cost of medication procurement and dispensing. Pharmacies encounter a lack of negotiating power and have described the contracts offered by PBMs as “take it or leave it,” further exacerbating their financial difficulties.
In recent fiscal reports, Walgreens indicated an operating margin of -5% for its U.S. retail pharmacy segment, down from 3.9% in 2019, while CVS’s pharmacy unit achieved an operating margin of 4.6% last year, a slight increase from 2022 but lower than margins from earlier years. CVS benefits from having its own PBM, meaning margin pressures might impact it less severely than at Walgreens.
To combat these pressures, CVS announced a new pharmacy reimbursement model, CostVantage, set to launch next year. This approach aims to provide transparency in medication pricing. However, analysts have expressed skepticism regarding its potential effectiveness. Furthermore, the surge in online pharmacy services, like PillPack (part of Amazon Pharmacy), is gradually shifting some consumer habits away from traditional retail chains.
Front-of-Store Woes
In addition to pharmacy challenges, Walgreens and CVS are also facing intense competition in their retail operations from e-commerce platforms, discount chains, and large retailers. Analysts have noted that these chains have been slow to establish robust online shopping platforms compared to rivals like Amazon and Walmart.
As inflation persists, consumers are increasingly conscious of their spending habits and are likely to choose lower-price alternatives over the pharmacies, even for convenience items. Freelancers like Brittainy Lynn from Austin, Texas, commented on the high prices at Walgreens and CVS, preferring to shop at retailers like Walmart or Target for better deals.
In recent quarterly reports, CVS revealed that same-store sales for non-pharmacy items decreased around 4% year-over-year, while Walgreens noted a 2.3% drop during the most recent fiscal quarter citing a tougher consumer landscape.
Both Walgreens and CVS are now concentrating on enhancing their private-label product offerings to attract budget-conscious consumers opting for less expensive options. Walgreens has reported success with its proprietary brand, planning to introduce even more items into its inventory.
Walgreens More Exposed to Retail Pharmacy Pressure
While Walgreens and CVS face similar market forces, Walgreens finds itself in a more precarious position due to its dependence on revenue from retail pharmacy operations, which constitutes the bulk of its revenue. Conversely, CVS’s broader healthcare services, including its insurance subsidiary Aetna, provide a buffer against challenges in the retail pharmacy sector.
For the fiscal year, CVS’s retail pharmacy segment delivered approximately $116.76 billion in revenue, while its health services business generated nearly $187 billion. In contrast, Walgreens reported over $109 billion from its U.S. retail pharmacy, overshadowing its international and healthcare segments.
Walgreens is attempting to diversify its revenue streams by expanding into health services, yet it is lagging behind CVS in this area. Both companies are investing in providing more direct patient care to capture a larger portion of the healthcare market. However, many industry players are facing losses due to heavy investments required to establish clinics and other healthcare services.
Walgreens has hinted at a potential exit from its investment in VillageMD, a primary care provider in which it invested significantly. After substantial losses, Walgreens started closing several VillageMD locations last year, leading to a substantial charge related to the investment.
What’s the Future of the Retail Pharmacy?
Despite the challenges, retail pharmacies are unlikely to fade from the landscape anytime soon, particularly as an aging population continues to require prescription services. Nevertheless, alterations to their business models seem inevitable. This could involve enhancing their online service capabilities, limiting certain product ranges, or reducing store sizes, as suggested by analyst Elizabeth Anderson.
Walgreens has recently introduced smaller-format stores, with a focus on reducing the range of merchandise in favor of pharmaceuticals and private-label items. The company aims to open around 100 of these stores, exploring new retail models that prioritize convenience and digital solutions to streamline operations and minimize theft.
CVS, for its part, is innovating as well, establishing Oak Street Health centers adjacent to CVS pharmacies to create a more integrated health service offering. This expansion includes plans for additional primary care centers over the next year.
Shuttering Stores to Shore Up Profits
Cost-cutting measures have become central to the strategies of both CVS and Walgreens. Walgreens has announced plans to close a significant portion of its U.S. stores, revealing that just 75% of its locations are profitable. The company indicated a potential reduction of unprofitable stores by 2027.
In 2021, CVS initiated the process of closing about 900 locations, nearly 10% of its retail footprint, citing factors such as demographic shifts and evolving consumer behaviors as driving forces behind its decision-making processes. Current estimates say that even after these closures, about 85% of the U.S. population will still reside within a 10-mile radius of a CVS location.
Industry experts believe that consolidating locations may aid CVS and Walgreens in recalibrating their operations while enhancing profitability. However, closures are also likely to create pharmacy deserts, particularly in underserved areas, complicating access to medications for vulnerable populations.
As the industry grapples with its myriad issues, the fundamental challenges may require more than just store closures as a solution, according to analysts like Saunders. He argues that tackling reimbursement rate declines may necessitate legislative action and advocacy, while merely closing stores could lead to similar predicaments down the line if deeper issues remain unaddressed.
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