On Tuesday CVS Health lowered its profit outlook, due partly to “the projected loss of more than 40 million retail prescriptions related to marketplace changes, including new retail pharmacy networks that are excluding CVS Pharmacy drugstores.” Its stock closed down 12%, before bouncing back slightly in yesterday’s post-Trump healthcare rally.
CVS Health placed the blame squarely on Walgreens Boots Alliance (WBA), which has aligned with Prime Therapeutics and displaced CVS retail pharmacies from the TRICARE retail network.
Call it competitive judo: Walgreens has used the strength of CVS Health’s integrated PBM/retail model against the CVS retail pharmacy business.
The lesson? Don’t bet against Stefano Pessina, our global channels overlord and executive vice chairman and chief executive officer of WBA. Read on for my analysis of the latest pharmacy showdown.
Post-election trivia question: In 2010, which former drug wholesale CEO (and future U.S. ambassador?) encouraged Donald Trump to run for President? Answer below!
THE QUARTER WITH NO NAME
As always, you should read the original source material for yourself. Here are links to the information about CVS Health’s third quarter earnings:
THE GOOD
CVS Health’s Maintenance Choice program is the most prominent limited network model for commercial plan sponsors. Under the program, a beneficiary can obtain maintenance medications from either a CVS retail pharmacy or a CVS Caremark mail pharmacy. This model lets consumers choose the pharmacy channel (mail or retail) but limits the choice to CVS Health dispensing channels.
Competing PBMs cannot readily match the Maintenance Choice program, because a separately owned PBM and pharmacy chain would battle over the per-prescription profit. CVS Health recently stated that Maintenance Choice and its other narrow network programs save payers about 5% to 8% of their non-specialty retail spend. See CVS Health’s Made-to-Order Networks white paper.
Plan sponsors—the pharmacy benefit management clients of CVS Caremark—have been quickly adopting the Maintenance Choice program. Below is Exhibit 87 from our 2016 Economic Report on Retail, Mail, and Specialty Pharmacies. In 2015, 23 million covered lives were enrolled in the program, up from 2.9 million in 2009.
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CVS Health’s retail business benefits from the Maintenance Choice program, which shifts prescription volume into CVS retail pharmacies from Caremark’s mail pharmacy and from other non-CVS retail pharmacies. We estimate that in 2015, Caremark PBM pharmacy network claims accounted for 36% of CVS retail pharmacies’ revenues. This exceeds Caremark’s overall market share.
THE BAD
Walgreens is now using the strength of Maintenance Choice’s integrated approach against CVS Health’s retail pharmacy business. Here’s what I told The Wall Street Journal in CVS Warns of Prescriptions Shift, Shares Tumble on Profit Warning.
But that leaves an opening for Walgreens to partner with other pharmacy-benefit managers. “CVS can’t have that same relations with other competing PBMs,” said Adam Fein of Philadelphia-based Pembroke Consulting, who tracks drug distribution. “Walgreens is using CVS Health’s strengths against it.”On its earnings call, CVS Health disclosed that the 40 million lost scripts would come from TRICARE (16 million), Prime Therapeutics (16 million), and “normal churn” (8 million). Here is a slide from the Tuesday’s earnings call that summarizes CVS Health’s view of “Marketplace Changes”:
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CVS Health’s losses correspond to Walgreens’ aggressive partnering strategy. As I told The Wall Street Journal: "Walgreens is trying to be the best friend of every PBM that’s not named Caremark." Here are the two relevant Drug Channels articles:
Note that CVS Health’s retail pharmacy business has backed away from Medicare Part D preferred networks. This volume was not included in the “lost” scripts that led to the 2017 profit figure. See Walgreens Plays to Win: Our Exclusive Analysis of 2017's Part D Preferred Pharmacy Networks.
CVS Health management seemed a bit shell-shocked by Walgreens’ actions. Here’s CFO David Denton:
“These major network changes quite honestly happened without a chance for us to actively engage and really tell our value proposition as these changes were contemplated in both Prime and with TRICARE. So from that perspective, we were kind of caught a little bit off guard.”As they say: When you have to partner, partner. Don't talk.
THE UGLY
The 40 million lost prescriptions account for less than 5% of CVS retail drugstores' volume. But these scripts to have a disproportionately negative impact on CVS Health’s retail profitability.
If you paid attention in your Econ 101 course, then you will be familiar with the concept of average vs. marginal costs.
For a typical pharmacy, total annual operating costs do not vary based on small changes in the total number of prescriptions dispensed. These costs include pharmacists’ high salaries and benefits and such general overhead costs as rent, utilities, insurance, advertising, computer systems, and other items. Consequently, the average cost of dispensing goes does down very slowly with each additional prescription filled. But the marginal (incremental) cost of dispensing one extra script is very, very low. (BTW, this is one reason “cost of dispensing” studies can be so misleading.)
On the earnings call, Larry Merlo, president and CEO of CVS Health, explained this brutal math:
“[W]e have always said that our last script is our most profitable one given our ability to leverage our fixed costs with incremental volume. And unfortunately, this means that the scripts we lose will tend to be our most profitable scripts, and as a result, we will de-lever, as a result of losing more than 40 million prescriptions.”The pharmacy industry has entered a new period of hypercompetition, which will yield winners and losers. As Mr. Pessina reportedly has said: In this pharmacy world there's two kinds of people, my friend—those in narrow networks and those who dig. You dig.
ANSWER TO TODAY'S TRIVIA QUESTION
For more on Mr. Rahr's infamous post-Kinray career, see this classic Drug Channels post: A Tale of Two Wholesaler CEOs.
Apparently, Mr. Rah-Rah is slated for "some sort of ambassadorship after the election." (See Meet Donald Trump's best pal, and possible future ambassador, Stewart 'Rah Rah' Rahr.)
I wonder if the Queen of England will be amused.
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