The WAG-CVS Brouhaha: What's Really Going On

Big news yesterday as Walgreen (NYSE:WAG) announced a very public spat with CVS Caremark (NYSE:CVS). See from Walgreen Cuts Ties With CVS Caremark Plans from today’s Wall Street Journal.

Below, I provide a road map to the key issues in this dispute. Although it’s really just about money, there are a lot of moving parts and many players here.

Regardless of the resolution, a Caremark spin-off is now even more likely per my prediction in When will CVS and Caremark split up?.

Rather than just reading what other people said about this news, I strongly encourage you to read the original statements:

• Walgreens Will Not Participate in Future CVS Caremark Pharmacy Network Plans
  
  
• CVS Caremark Issues Statement in Response to Walgreens Unexpected Announcement

OBSERVATIONS

Maintenance Choice works…for CVS. Maintenance Choice is having a competitive effect, and Walgreens is drawing a line in the sand to challenge this program. Maintenance Choice pushed CVS’ same-store pharmacy sales growth above Walgreen’s growth starting in early 2008. See the chart in CVS Grows While Legal Storm Clouds Gather. This above-market growth came from a mix of cannibalizing its own mail-order pharmacy and share gains from competing pharmacies. Note that Walgreen is not walking away from current Caremark business, only “new and renewed plans.” Translation: They want CVS Caremark to stop selling Maintenance Choice. Alternatively, they would love a chance to play in the network a la Walgreen's own Advantage90 program.

Walgreen likes to play hardball. CVS stated that “Walgreens has tried this approach several times in the past, targeting employers, health insurers and government entities.” This is actually true. Walgreen has a long history of pushing back against payers when it feels undercompensated. Examples include Washington’s Medicaid program and Michigan HMO Midwest Health Plan.

These titans have clashed before. This isn’t even the first battle between Walgreen and Caremark. Check out More Legal News: Caremark v WAG from the Drug Channels archives. In 2007, Walgreens prematurely cancelled its Provider Agreement to fill prescriptions for four health benefit plans managed by Caremark, claiming that CVS Caremark had unilaterally reduced payments. CVS subsequently sued Walgreen. Everyone eventually made up.

But still, WTF? I’m puzzled as to why Walgreen picked this fight in such a public way. They would ultimately be the loser if they really walked away from new Caremark business. Walgreens mentioned that about 12% of its retail prescription revenue (about 7% of its total revenue) came from claims processed by Caremark’s PBM business, which is surprisingly low. For comparison, about 22% of prescription revenue at CVS pharmacies came from Caremark. (See Maintenance Choice Update: CVS Gain, Caremark Same.)

Walgreen hit ‘em when it hurts. Walgreen timed their maneuver to inflict maximum pain. It’s no coincidence that the announcement hit shortly after happy talk from Caremark about the 2011 Pharmacy Benefit Manager (PBM) selling season. Last week, Tom Ryan said: “We're in a really good position around our business, one for retaining clients, but two, also for new clients on a go-forward basis.” (source) This week, things don't look so rosy.

Surprise! The NCPA is gloating. The National Community Pharmacists Association (NCPA), which lobbies on behalf of independent pharmacies, could barely contain their glee at the news. In typically over-the-top fashion, they said: “Walgreens' momentous decision is an indictment of all that has gone wrong for patients and the practice of pharmacy since the CVS Caremark merger in 2007.” (source) It reminds me of a line from a Neko Case song: “The night I fell into the lion's jaws; To my regret and your delight.”

Pure play PBMs are the real winners. While neither Express Scripts (NASDAQ:ESRX) nor Medco Health Solutions (NYSE:MHS) have weighed in publicly, this news will be positive for the pure-play PBMs in the current selling season. A protracted dispute will create even more momentum for the pure-play PBMs.

Walgreen is being a bit hypocritical. F. Scott Fitzgerald famously said that “the true test of a first-rate mind is the ability to hold two contradictory ideas at the same time.” By this standard, the folks at Walgreen must be geniuses. Walgreen complains that MC “limits patient choice.” Hmmm, doesn’t Walgreen’s arrangement with Caterpillar also use a preferred pharmacy network model? What about the rumored direct-to-payer deal with Delta?

I’ll leave you with one extra-controversial thought:

A Caremark spin-off is even more likely. We now have another example of negative synergy. Even if this dispute is resolved, the damage is already done. Payers will question the wisdom of signing on with a PBM that can’t properly manage its retail network. See When will CVS and Caremark split up? for more on my rationale for a separation.