CVS Escalates the Generic Price War

Did anyone else notice the recent move by CVS Caremark (CVS) to offer a discount generic program?

Walgreens caved into Wal-Mart last June when it reversed course and started promoting the Walgreens Prescription Savings Club. See my post Walgreens’ $4.33 Surrender to Wal-Mart.

Now it’s CVS pharmacy's turn, but with the added confusion that the company also runs one of the largest mail order pharmacies. If we put aside the spin, the new program sounds like a logical pre-emptive strike against anticipated share losses. Translation: an old-fashioned, race-to-the-bottom price war!

A barrier has been breached with CVS’ entry into the discount retail generics game. Sorry to be the bearer of bad news, but it’s inevitable that this war will suck a lot of margin from the pharmacy and PBM industry over the next few years.

WHAT CVS SAYS

On Monday, CVS launched its new Health Savings Pass, which allows customers to buy 90 day supplies of over 400 generics for $9.99 (after paying an enrollment fee of $10). Tom Ryan said the following on CVS’ October 30 earnings conference call: “Let me be clear, I told you that we haven’t seen a material share loss due to our competitor’s $4 generic program and that’s still the case today.”

OK, let’s assume that he includes all types of retail pharmacy within the definition of “competitor.” So we can conclude that the generic programs of Wal-Mart (WMT), Walgreens (WAG), Kroger (KR), et al are apparently not having a material effect on CVS’ retail sales.

Why give up the generic margin? Mr. Ryan offered the following explanation, which I have parsed into two separate components:

• “We’re in the middle of an understated [sic] difficult economic crisis to say the least. People are struggling with healthcare costs more than ever before especially the under and un-insured. We felt it was the right time to offer a differentiated affordable option.”
• “Given the enrollment fee and the fact that we expect some share gain and increased foot traffic we think the RX Health Savings Pass shouldn’t cost us more than $0.01 or so per share on an annual basis.”

Sorry, but I don’t follow the logic about market share gains with the uninsured and under-insured in the first statement. Third-party payers represented 95.3% of CVS Caremark's retail revenue in 2007 (per their 10-K). The retail chain has never historically competed on price.

The second statement is more telling. Sure, the enrollment fee will help maintain loyalty as consumers try to amortize the fixed annual cost over their scripts. The $10 per customer will also provide some (non-reimbursement related) cash flow to cushion their loss of generic margin.

CVS VS. CVS

Frankly, I’m puzzled by the fit between the new generic program and the legacy Caremark mail order business. Mail order becomes less attractive if a 90-day mail script is the same (or more than!) three 30-day retail scripts. Perhaps CVS Caremark is counting on additional front-end sales to balance out lost mail margin, but I have trouble making the math work. Maintenance Choice, which is apparently gaining some marketplace traction, relies on a similar internal retail-versus-mail profit tradeoff.

I’m curious to hear from Drug Channels readers. What’s happens next in the retail pharmacy industry?