Retail Pharmacy Chains Face a Prescription for Change: Shuttering Stores and Rethinking Strategies
The ubiquity of Walgreens and CVS Health stores makes them a convenient go-to for many Americans, but these pharmacy giants are facing a perfect storm of challenges, forcing them to shutter hundreds of locations and rethink their business models. Low reimbursement rates for prescription drugs, increased competition from online retailers and big-box stores, and rising inflation are squeezing their profit margins, particularly in the traditionally lucrative front-of-store sales. The situation is so dire that Walgreens stock has plummeted nearly 60% this year and CVS Health is facing similar struggles, with its insurance business hit by escalating medical costs.
Key Takeaways:
- The retail pharmacy model is under pressure: Lower reimbursement rates from pharmacy benefit managers (PBMs), competition from online retailers and big-box stores, and inflation have made it difficult for pharmacies to turn a profit.
- Walgreens is more vulnerable: Walgreens relies more heavily on its retail pharmacy business compared to CVS Health, which benefits from its insurance and PBM divisions.
- Store closures are a symptom, not a solution: While shuttering underperforming locations can help right-size operations, addressing fundamental issues like PBM reimbursement rates requires broader systemic changes.
- Innovation is key: Chains are experimenting with smaller-format stores, digital pickup options, and increased focus on private-label brands to attract budget-conscious shoppers.
Falling Pharmacy Reimbursement Rates
One of the biggest headaches for retail pharmacies is the declining reimbursement rates they receive for prescription drugs. Pharmacies purchase medications from distributors and then seek reimbursement from pharmacy benefit managers (PBMs), powerful middlemen who negotiate discounts with manufacturers on behalf of insurers and manage prescription drug coverage for health plans.
The three largest PBMs, CVS Health’s Caremark, UnitedHealth Group’s OptumRx, and Cigna’s Express Scripts, control nearly 80% of the US prescription market. Pharmacies accuse PBMs of setting unfairly low reimbursement rates, in some cases, even paying less than the cost of buying and dispensing the medication. These middlemen are also criticized for offering "take it or leave it" contracts, effectively forcing pharmacies to accept low rates or risk losing access to patients covered by PBMs. This leaves pharmacies with limited leverage and tight margins.
Walgreens’ US retail pharmacy unit saw a -5% operating margin last year, a sharp decline from 3.9% in 2019 and 4.4% in 2015. Meanwhile, CVS Health’s pharmacy and consumer wellness business saw a 4.6% operating margin last year, a slight improvement from 2022 but still significantly lower than 8.5% in 2019 and 9.9% in 2015. While CVS has a slight advantage with its own PBM, Caremark, it’s still facing pressure on its margins.
CVS introduced a new reimbursement model, CostVantage, which aims to provide more transparency and predictability in medication pricing. However, analysts are still unsure about its effectiveness.
Front-of-Store Woes
The challenges don’t end at the pharmacy counter. E-commerce rivals, discounters, and big-box retailers are putting intense pressure on the front-of-store sales at Walgreens and CVS. Amazon, Walmart, Target, and other retailers have outpaced the pharmacy chains in online retail, making it less likely for shoppers to turn to CVS.com or Walgreens.com for their everyday needs.
Adding to the pressure, inflation is prompting consumers to be more budget-conscious and seek cheaper alternatives. Shoppers are more likely to head to Walmart, dollar stores, or Costco despite the convenience offered by pharmacies.
CVS reported a nearly 4% decline in same-store sales at the front of the store in the second quarter compared to the previous year, attributed to the softening of consumer demand. Walgreens also experienced a 2.3% decrease in same-store retail sales during its fiscal third quarter, citing a challenging consumer environment.
Both chains are focusing on their private-label products to appeal to value-driven shoppers and offset inflation. While Walgreens sees "strong success" with its private-label brands, it’s unclear if these efforts will be enough to turn the tide.
Walgreens More Exposed to Retail Pharmacy Pressure
While both chains are grappling with similar challenges, Walgreens faces a more precarious situation than CVS Health due to its heavier reliance on its retail pharmacy business. CVS Health benefits from its PBM and the nation’s third-largest health insurer, Aetna, which provides a cushion for its retail pharmacy operations.
Last year, CVS Health’s retail pharmacy unit accounted for $116.76 billion in revenue, making it the company’s second-largest revenue generator. Its health services segment, including Caremark and Oak Street Health (primary care), generated nearly $187 billion in sales.
In contrast, Walgreens sources the majority of its revenue from US retail pharmacies, generating over $109 billion last year compared to $21.83 billion from its international segment and $1.8 billion from its healthcare unit.
While Walgreens is attempting to diversify through its healthcare unit, it has been playing catch-up to CVS in this space.
What’s the Future of the Retail Pharmacy?
The retail pharmacy industry is not going extinct, especially with an aging population requiring prescriptions. However, the traditional model needs to adapt. This includes increasing online presence, potentially focusing on core pharmacy offerings rather than a wide range of front-of-store products, and shrinking store footprints.
Walgreens is testing smaller-format stores, focusing on pharmacy services and grab-and-go items. It’s also piloting a Chicago store with a focus on digital pickup and pharmacy services. CVS is also adapting with its own initiatives, including the expansion of Oak Street Health primary care centers alongside CVS pharmacies.
Shuttering Stores to Shore Up Profits
As a cost-cutting measure, both chains are closing underperforming locations. Walgreens announced plans to shut down a significant number of its 8,600 US stores, acknowledging that only 75% are currently profitable.
CVS also announced the closure of 900 stores, or nearly 10% of its US retail locations, over a three-year period. It’s on track to meet this goal by the end of the year.
While store closures can help streamline operations, they don’t address the systemic issues plaguing the retail pharmacy industry. Reimbursement rates from PBMs are unlikely to change without legislation and lobbying efforts. The future of retail pharmacies may require a more comprehensive approach to innovation, adaptation, and policy changes to survive and thrive in the years to come.
