Amazon (Probably) Is About to Lose Out

Dear Jeff Bezos:

It looked like a great idea when you started to build a team of healthcare specialists back in the summer. Despite — or perhaps because of — endless attempts to control costs and improve quality, American healthcare remains (in the words of a recent THCB post) “a version of Afghanistan…replete with tribal conflicts, warlords, corruption, a bad communication system, [and] language problems.” Surely, there must be opportunities for Amazon.

Healthcare reporters were quick to pick up on rumors of your company entering the pharmacy business. If Amazon’s purchasing, distribution, delivery and marketing skills could be applied to the Whole Foods grocery business, imagine what might be achieved in the $500 billion pharmacy market. And imagine how this base could be used to transform the entire healthcare industry. No wonder drugstore chains and drug manufacturers saw their stocks swoon as the rumors spread.

Now it seems Amazon may have been aced out.

CVS Health, the largest retail pharmacy chain and a major pharmacy benefits manager, is in talks to buy Aetna, the third largest US health insurer, for more than $66 billion. While some analysts see this as primarily a defensive maneuver to thwart Amazon, it has the potential to dramatically change the healthcare playing field.

In the short run, both CVS and Aetna would be better protected against their current weaknesses. CVS’ PBM business is increasingly vulnerable as major insurers bring drug negotiations in-house, while its retail stores face growing competition from on-line pharmacies and – more recently – from federal approval of Walgreens’ acquisition of Rite-Aid. Aetna has its own weaknesses: it lost money on the Obamacare exchanges, and the continuing move of large groups to ASO contracts means less profitable underwritten business.

In the longer run, the possibilities are huge, with a CVS-Aetna combination potentially upending the healthcare marketplace. CVS could put more and more MinuteClinics into its stores with Aetna encouraging their use by its members. The MinuteClinics could then be expanded into full service primary care clinics—with pharmacies just feet away! Suddenly, there’s the potential for an HMO far larger than Kaiser, with a friendlier retail environment and thousands of locations already serving the member base. It could be the future face of American healthcare.

Has Amazon missed its big chance? Not necessarily, but the kinds of initiatives analysts have tied to the summer hirings offer limited potential. Healthcare advice or prescription ordering via Echo? Marginal opportunities only. It’s possible to see Echo as key to much of Amazon’s on-line retail business, but the risks and penalties for errors in voice recognition ordering of prescription drugs seem too great. Telemedicine and medical data analysis? Others, with better access to insurers and providers, have been working on such projects for years. (And take a look at how well Google Health and Microsoft HealthVault have done!)

So, what should Amazon do?

First, forget about acquiring retail pharmacies for the moment. There’s no point in going after Walgreens as it tries to digest its Rite-Aid acquisition, and there’s no other independent chain approaching CVS’s size. Second, introduce pharmacies into the Whole Foods stores, increasing revenue while learning the complexities of government pharmaceutical regulations, along with the unique problems of monopolistic specialty drug manufacturers. Third, and definitely later, acquire a PBM, giving members the choice of mail delivery or Whole Foods pickup and providing a captive customer market. Then, maybe, with all these pieces in place, it will be time to acquire – or build – a pharmacy chain able to go head-to-head with CVS.

And then the healthcare business will really change.

Roger Collier was formerly CEO of a national healthcare consulting firm.


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4 replies »

  1. I think Amazon is barking up the wrong tree on this one for several reasons.

    First, take prescription drugs. Three large drug wholesalers, Amerisource-Bergen, Cardinal Health and McKesson, account for most of that part of the drug distribution chain. Three large PBM’s, Express Scripts, CVS-Caremark, and the Optum Rx division of UnitedHealth Group, account for 75%-80% of that market. The second largest health insurer, Anthem, will pull its PBM business in house when its ten year contract with Express Scripts expires in 2020. Anthem currently accounts for 31% of Express Scripts’ revenue. Generic drugs account for close to 90% of all prescriptions written but less than 30% of the dollars spent on drugs and the two big drugstore chains, Walgreens and CVS, already have significant buying power in negotiating prices with generic drug manufacturers. Nobody has much market power in negotiating with the branded and specialty drug manufacturers. Their attitude is that if the doctors prescribe it, you have to carry it and the price is the price less any volume based rebates that the PBM’s negotiate on payers’ behalf.

    In drug retailing itself, the supermarkets and big box stores generally don’t make money on their pharmacies. They offer them as a convenience for their customers and accept losing money because they have so many other things to offer customers while they’re in the stores. A Walgreens executive told me a number of years ago that a pharmacy needs to fill an average of 250 prescriptions per day to make money. My local Costco fills about half of that. I don’t think Whole Foods will attract more customers to their stores by adding a pharmacy if they don’t already have one. For the drug retailers, it’s their core business. They must and do make money on their pharmacies which account for about 65% of their revenue.

    In the rest of healthcare, there are surprisingly few economies of scale, especially in primary care. Hospitals that own primary care practices generally lose money on the primary care itself but expect to make money on the referral business generated by the PCP’s assuming most of it stays within the hospital’s system. There is money to be made in urgent care clinics and ambulatory surgical centers and United acquired its way into both of those niches over the last couple of years.

    I don’t see where or how Amazon can disrupt any part of the healthcare market unless it doesn’t care about making money which seems to be the case, at least so far, with its online retail business. They’re fortunate to have Amazon Web Services which is a big profit generator for them.

    • Thanks Barry, for some interesting comments.
      However, you might want to check your 250 prescription a day breakeven figure for Walgreens. Their website FAQs say they fill 990 million prescriptions per 30-day period, which averages out to around 4,000 a day per store, although this figure doesn’t take into account on-line and mail order prescriptions.
      I agree that it would not be easy for Amazon to disrupt the healthcare market, but given that there seem to be plenty of other companies making a comfortable living, don’t you think there might be opportunities for an enormously wealthy and patient competitor?

      • Thanks Roger. As of the end of fiscal 2016 (8/31/16), Walgreens operated 8,175 stores in the U.S. and Puerto Rico. Using your figure of 990 million adjusted (30 day equivalent) scripts filled per year equals 121,100 scripts per store per year or approximately 332 per day which would make Walgreen’s pharmacies solidly profitable based on their 250 per day metric to make money. The pharmacy is the core business for Walgreens and CVS. They must make money there to have a viable business model. That is not the case for supermarkets and big box retail stores like Wal-Mart and Costco. Interestingly, Target sold all of its pharmacies to CVS which now operates them in Target stores under the CVS name. The mail order pharmacies operated by pharmacy benefit managers are very capital intensive operations and fill many thousands of scripts per day mostly for maintenance medications.

        One interesting thing about much of healthcare is that there are surprisingly few economies of scale. This is true for hospitals just as it’s true for multi-family apartment buildings, office buildings and other commercial real estate. Large physician practices may well have diseconomies of scale because they need more management infrastructure as they increase in size.

        Pharmacies buy most of their drugs from drug wholesalers though the big chains can buy generics direct and play competing manufacturers off against each other. I doubt Amazon could do that any better than the three large drug wholesalers and the two big drug retailers are already doing it. I also don’t think Amazon could negotiate better deals with brand name drug manufacturers that the three large PBM’s are already doing it. Besides, patients need a prescription from a doctor or NP or PA before they can fill it and acute drugs are usually needed immediately, not two or three days from now. As noted above, the mail order pharmacies are highly efficient capital intensive operations and I don’t think Amazon could do a better job there either from a cost standpoint. I don’t think they are likely to be successful selling drugs at a loss and I doubt that investors would tolerate such a strategy for very long.

  2. Roger, thanks for the interesting analysis and it’s one I largely agree with.

    That being said, Amazon may be actually be smart sitting this one out as they get to now see how regulators will react to the vertical integration of retailer, insurer and PBM. Better to be the follower than the guinea pig in a lot of circumstances.

    Also, the option to buy 2500 Rite Aid stores is still there and I’m not totally unconvinced that Amazon couldn’t pursue a purchase or even merger with Walgreens down the road. I agree with you that opening up pharmacies in Whole Foods would be the more sustainable option by reducing B&M footprint and costs but it’s still there.

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