Generic Drugs · December 1, 2021 · Drug Channels Institute, an HMP Global company
CVS Pharmacy Downsizes: 10 Industry Trends Driving the Retail Shakeout
ICYMI, CVS Health recently announced that it will close about 900 of its retail pharmacies. This downsizing complements the company’s shift toward its healthcare delivery future.
This long-overdue move highlights the retail industry’s fundamental economic headwinds. The pharmacy shakeout is accelerating, as smaller competitors exit and larger companies reduce store count.
To help you make sense of CVS’s move, below I outline 10 crucial forces of change reshaping the retail pharmacy industry.
For more on pharmacy’s future, please register for Drug Channels Outlook 2022, my live video webinar that will air on December 17, 2021.
THE TOP TEN
Retail pharmacies are experiencing a period of intense competition that continues to pressure prescription profits. After years of stability, the number of U.S. pharmacy locations across all formats is trending downward.
Here are 10 key forces behind deteriorating retail pharmacy industry margins:
1) Slow retail prescription growth and intense competition for consumers.
We have an oversupply of U.S. pharmacy locations. Growth rates for 30-day equivalent prescriptions has remained in the low-single-digit range for many years. In most regions, consumers have no shortage of locations from which to choose. Nearly 9 out of 10 Americans live within one mile of a community retail pharmacy location.
Mail pharmacies are not responsible for this retail surplus. Over the past 10 years, total prescriptions dispensed by mail pharmacies have declined, while prescriptions filled at retail community pharmacies have increased.
Mail pharmacies are not responsible for this retail surplus. Over the past 10 years, total prescriptions dispensed by mail pharmacies have declined, while prescriptions filled at retail community pharmacies have increased.
2) Low generic drug prices.
In a retail pharmacy, generic prescriptions account for more than 90% of the dispensing activity. The overall prices of generic drugs are low, which restrains these prescriptions’ revenues and gross profit dollars. Retail pharmacies can extract only so much money from a prescription that has a total reimbursement of $25.
What’s more, over the past few years, the prices of oral solid generic drugs have been declining. During 2017 and 2018, deflation ranged from -10% to -15%, before moderating somewhat during 2019 and 2020. In 2021, generic deflation has returned to the -5% to -10% range.
What’s more, over the past few years, the prices of oral solid generic drugs have been declining. During 2017 and 2018, deflation ranged from -10% to -15%, before moderating somewhat during 2019 and 2020. In 2021, generic deflation has returned to the -5% to -10% range.
3) Slower growth in brand-name drug list prices.
Despite what you may have heard from politicians, brand-name drug list prices are growing at their slowest rate in at least 20 years.
Brand-name prices remain crucial to explaining and understanding pharmacies’ economics. A pharmacy’s revenues and gross profits from dispensing a brand-name drug are related closely to the brand-name drug’s list price. Consequently, gross profit dollars per prescription have also been growing more slowly.
Brand-name prices remain crucial to explaining and understanding pharmacies’ economics. A pharmacy’s revenues and gross profits from dispensing a brand-name drug are related closely to the brand-name drug’s list price. Consequently, gross profit dollars per prescription have also been growing more slowly.
4) Limited exposure to the dispensing of specialty drugs.
Pharmacy industry revenues have been shifting from traditional brand-name drugs to specialty drugs. Specialty drugs now account for about 40% of the pharmacy industry’s prescription revenues—but represent only 13% of prescription revenues at retail chain pharmacies.
Most of the revenues from pharmacy-dispensed specialty drugs are earned by mail pharmacies that are fully or partially owned by one of the largest PBMs…which are themselves part of large, vertically-integrated organizations. (See DCI’s Top 15 Specialty Pharmacies of 2020: PBMs Expand Amid the Shakeout—While Walgreens’ Outlook Dims.) We project that by 2025, specialty drugs will have accounted for almost half of the pharmacy industry’s revenues. That means retail pharmacies are under-indexed to the fastest-growing part of the pharmacy industry.
Most of the revenues from pharmacy-dispensed specialty drugs are earned by mail pharmacies that are fully or partially owned by one of the largest PBMs…which are themselves part of large, vertically-integrated organizations. (See DCI’s Top 15 Specialty Pharmacies of 2020: PBMs Expand Amid the Shakeout—While Walgreens’ Outlook Dims.) We project that by 2025, specialty drugs will have accounted for almost half of the pharmacy industry’s revenues. That means retail pharmacies are under-indexed to the fastest-growing part of the pharmacy industry.
5) Reduced margins from participating in payers’ narrow retail pharmacy networks.
Narrow pharmacy networks—both preferred and limited models—are a widely accepted and utilized element of pharmacy benefit design. Narrow network models encourage or require consumers to use designated pharmacies or channels instead of allowing them to choose from an open network containing almost all pharmacies. Such networks dominate Medicare Part D plans and constitute a significant presence within commercial health plans.
Retail pharmacies are trying to remain competitive and attract consumers in a saturated retail dispensing market. They are therefore willing to reduce their gross margins in exchange for growing (or even maintaining) store traffic. A pharmacy’s fixed-cost structure encourages such competition for network position. Consequently, the reduction in pharmacy profits is the biggest source of cost savings from narrow networks.
Retail pharmacies are trying to remain competitive and attract consumers in a saturated retail dispensing market. They are therefore willing to reduce their gross margins in exchange for growing (or even maintaining) store traffic. A pharmacy’s fixed-cost structure encourages such competition for network position. Consequently, the reduction in pharmacy profits is the biggest source of cost savings from narrow networks.
6) Lower reimbursement and store traffic from 90-day maintenance prescriptions.
The number of 90-day prescriptions has been increasing in community retail dispensing formats. In 2020, about one in four prescriptions filled in a retail chain was for a 90-day supply. During 2021, the share has come down slightly, but it remains higher than the pre-pandemic figures.
This growth reflects pharmacies’ competitive position and payers’ benefit strategies. Plan sponsors and PBMs have adopted narrow network models that increase 90-day-at-retail prescriptions. Ironically, smaller pharmacies have actually encouraged a race-to-the bottom price war, by lobbying states to pass anti-mandatory mail order legislation. Consequently, retail pharmacies can now fill 90-day prescriptions—as long as they accept lower mail pharmacy reimbursement rates.
This growth reflects pharmacies’ competitive position and payers’ benefit strategies. Plan sponsors and PBMs have adopted narrow network models that increase 90-day-at-retail prescriptions. Ironically, smaller pharmacies have actually encouraged a race-to-the bottom price war, by lobbying states to pass anti-mandatory mail order legislation. Consequently, retail pharmacies can now fill 90-day prescriptions—as long as they accept lower mail pharmacy reimbursement rates.
7) Rapid growth in direct and indirect (DIR) remuneration rebates.
Pharmacy DIR payments to Medicare Part D plans are now large enough to have a significant effect on pharmacy economics. We estimate that the net value of pharmacy price concessions reached $11.2 billion in 2020. That equates to about 2.4% of pharmacy industry revenues. See our chart in CVS, Walgreens, Walmart, and Supermarkets Keep Position in 2022 Part D Preferred Networks—With a Little Help from 340B.
8) Retail pharmacy’s cost structure.
For a typical pharmacy, total annual operating costs do not vary based on small variations in the total number of prescriptions dispensed. These costs include pharmacists’ salaries and benefits, as well as such general overhead costs as rent, utilities, insurance, advertising, computer systems, and other items. (Recall that the average pharmacist earns about $125,000 in base salary.)
Consequently, the marginal (incremental) cost of dispensing one extra script is very low. This cost structure encourages the competition for network position, described above. It’s also a key reason cost-of-dispensing studies present a misleading picture of pharmacy profitability for filling an incremental script.
To counter these industry headwinds, chain drugstores have become larger and busier than other formats. For example, the average number of equivalent prescriptions per chain drugstore has grown by more than 60% since 2010. (See Exhibit 34 of our 2021 pharmacy/PBM report.) Per-store averages have also increased over the past few years, because the number of pharmacies has declined.
Consequently, the marginal (incremental) cost of dispensing one extra script is very low. This cost structure encourages the competition for network position, described above. It’s also a key reason cost-of-dispensing studies present a misleading picture of pharmacy profitability for filling an incremental script.
To counter these industry headwinds, chain drugstores have become larger and busier than other formats. For example, the average number of equivalent prescriptions per chain drugstore has grown by more than 60% since 2010. (See Exhibit 34 of our 2021 pharmacy/PBM report.) Per-store averages have also increased over the past few years, because the number of pharmacies has declined.
9) Growing competition from technology-enabled online pharmacies.
A growing number of technology-enabled digital pharmacies have received substantial venture capital financing. These companies have not gained material pharmacy industry market share. I believe, however, that they will soon start to force industry incumbents to improve their businesses and approach to patients, per my comments in The Promise and Limits of Digital Pharmacies.
Of course, most people just want to talk about Amazon. As I noted in November, I don’t underestimate Amazon. But for now, Bezos and Co. seems content to join the drug channel, not fundamentally change it.
Of course, most people just want to talk about Amazon. As I noted in November, I don’t underestimate Amazon. But for now, Bezos and Co. seems content to join the drug channel, not fundamentally change it.
10) Potential Policy Changes.
Public policy changes may also fan pharmacy headwinds. For instance, there will eventually be significant changes to contract pharmacies in the 340B Drug Pricing Program, where CVS is a major player. If the Build Back Better bill passes, its drug pricing elements would raise pharmacies’ costs for serving Medicare Part D patients.
SHAKEOUT AND CONSOLIDATION
Together, the 10 trends above have created intense competitive pressures that have led many regional chains and independent pharmacies to exit the industry. Most of these companies have been acquired. From 2010 through 2021, the three largest chain drugstores acquired more than 5,000 locations from smaller competitors. These chains also acquired an unknown number of independent pharmacies.
The chart below tracks the total number of U.S. retail pharmacy locations of CVS Health and Walgreens Boots Alliance.
- Walgreens’ store count peaked in mid-2018 at more than 9,900 stores, after it acquired nearly 2,000 Rite Aid stores. Walgreens has since eliminated almost 1,000 stores.
- By contrast, CVS in 2015 acquired the nearly 1,700 pharmacies inside Target stores. This deal boosted CVS’s store count above 9,500. It has since grown to almost 10,000 locations. The company's recent announcement will be its first major culling of retail stores.
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You can find additional details about these trends in our 2021 Economic Report on U.S. Pharmacies and Pharmacy Benefit Managers. Item 7 in the report’s Preface contains clickable links to the sections in the full report that are most relevant to the retail pharmacy shakeout.
As you plan your own organization’s response, here’s a final thought from John Maxwell: “Change is inevitable. Growth is optional.”
Generic Drugs · Industry Trends · Direct and Indirect Remuneration (DIR) · Pharmacy · Specialty Drugs · Channel Management · Narrow Networks · PBMs · Pharmacy Economics