Rethinking Strategy in Pharmacy and Drugstore Retailing
By John S. Strong
After a long period in which the drugstore business was both consistently profitable and growing, pharmacy retailing is undergoing significant changes worldwide. The industry is facing unprecedented changes in health care systems, the changing nature of pharmaceuticals, innovations in products and services, and rising competition from new entrants and new channels. This context has prompted fundamental rethinking about strategy.
The pharmacy is in some ways different than many other retail sectors. As part of the health care system, the community pharmacy sector is not a traditional supply-and-demand market. A three-tier system (supplier – payer – consumer), a low price elasticity, and information asymmetry characterize public health care systems, including the pharmacy sector. Therefore a minimum degree of public regulation is necessary, which has been implemented in very different ways.
The pharmacy/drugstore industry also differs dramatically across countries. The way the pharmacy sector is organized and regulated has been considerably influenced by historic developments, traditions, and cultures. What works well in one country is not necessarily successful in another country.
The pharmacy sector covers a broad spectrum of ownership and establishment regulations across countries.1 The United States is the most liberal, with pharmacists typically being employed by retail chain drug stores. Canada requires that pharmacists own drug stores, but the number of establishments and the organizational form this ownership takes is quite liberal. For example, Shoppers Drug Mart is by far the largest drugstore chain in Canada, with 1,295 locations. Shoppers operates with pharmacists as licensed associate-owners combining independent business ownership, professional practice, and cooperative services under one brand, with the support of a corporate entity. Shoppers Drug Mart is in effect a network of independently owned dispensaries housed inside a retail drugstore chain.
Europe has perhaps the widest variety of ownership and operating structures. The Anglo-Irish-Dutch pharmacy industry is most similar to the U.S., being largely a free market approach in which ownership can be separated from operations. The dispensary business is largely based on fee for service remuneration for prescription drugs, rather than set and guaranteed margins for script medicines. The U.K. and the Netherlands, like the U.S., are leading the way in expanding into the provision of health care services. The Nordic countries [Denmark, Sweden, Norway, and Finland] historically had government-owned and operated pharmacies (apotek) but have embarked on large-scale privatization and liberalization of services. The limited government network resulted in low pharmacy density, so that privatization and liberalization has brought both new locations and consolidation into a handful of pharmacy groups. Given the high costs and centralized legacy, the Scandinavian pharmacy sector has had a distinct approach, emphasizing technology and e-prescriptions, along with high penetration of cheaper generic drugs. Continental Europe [Germany, Austria, Belgium, France, Spain, Italy, Greece, and Portugal] has inherited a historical guild system, with traditional regulation. In these countries, there are many smaller pharmacies, very high pharmacy density, low generic penetration, and margin-based remuneration. In Eastern Europe, the pharmacy industry is in transition—in some cases, extreme free market approaches and in others, instances of limited or ineffective regulation.
In Australia and New Zealand, regulatory restrictions have resulted in a fragmented industry, yet franchise-based systems are leading to drugstore chains and models of multiple ownership and operation. The more developed economies in East Asia and Latin America generally have pharmacy ownership and operating regulations that are similar to those in either the U.S. or Canada, enabling the development of retail drug chains such as Watson’s, Guardian, and Mannings in Southeast Asia, and Farmatodo in South America. Less-developed countries in Asia, Latin America, and Africa tend to have tight ownership and licensing restrictions, so that their pharmacy sectors look more like Continental Europe. In many of these developing countries, regulatory oversight is constrained by governments which lack the enforcement staff, budgets, or regulatory and judicial framework that exists in developed countries. Enforcement is made particularly difficult because the retail market in most low-income countries is highly fragmented: the number of formal pharmacies is small compared to the many different types of retailers, such as dispensing doctors, medicine sellers, drug sellers, and general stores that also sell a variety of drugs and health care remedies.2
Within these diverse national structures, though, the retail pharmacy sector is facing a common set of global challenges. These include:
- Rising costs and pressure on health care industry manufacturers, as many blockbuster-branded drugs come off patent protection and move to generic status. The effect can be seen in Canada, where compensation for six widely used drugs has been priced as generics at 18 percent of the prior price for the brand equivalent.3 In the Netherlands, tendering for generic formulation led to price declines between 76 and 93 percent for 10 widely used drugs.4 This decline in remuneration is particularly problematic because the pipeline of new drugs has slowed. Many new drug therapies are patient specific and require specialized technology (such as infusion therapy). Soaring research costs have left the big pharmaceutical companies struggling to grow, with knock-on consequences for pharmacy retail.
- Increase in the number of widely used drugs moving from prescription to over-the-counter (OTC) status. In the U.S., 106 ingredients in more than 700 widely used medicines have moved from prescription to OTC in the past 30 years.5 This has completely changed the pharmacy role in categories such as cough-and-cold, allergies, antacids, and insomnia. While OTC has brought greater drug volumes, prices have fallen and such products are now sold widely across other retail channels such as supermarkets and discount department stores.
- Escalating cost pressures from regulatory agencies and payers. For most countries with publicly run health care, government budgetary pressures are leading to lower pharmacy compensation. In the U.S., the consolidation of pharmacy benefit management companies has acted in a similar fashion, forcing lower prices and margins while shifting prescription volumes to direct or mail-order fulfillment. This trend will continue as government-operated health care exchanges (Obamacare) are rolled out beginning in 2014. With this change in the U.S. health care structure, governments will be the largest payer of health care costs in virtually all countries. This, in turn, creates additional pressures on taxpayers and on government borrowing, with consequent effects on pharmacy retail.
- Increasing health care needs of an aging global population.6 People are living significantly longer and fertility rates are declining. Global life expectancy rose from 48 years in 1950 to 68 by 2010, and is expected to rise to 76 by 2050. The percentage of the population older than 60, currently 11 percent, is expected to double during that period. The share of the oldest old (80 or older) is expected to grow even faster. Since medical spending increases dramatically with age, the demand for more widely available but cheaper drugs will grow. This will place new pressures on operations and margins.
- Growing middle class population in emerging markets.7 The OECD estimates that the global middle class was approximately 1.8 billion people in 2010, but that continued growth in developing countries will result in a middle class of 3.2 billion by 2020 and 4.8 billion by 2030. As incomes rise, spending on health care products and services tends to grow disproportionately. This growth in demand will require significant improvement in scale and efficiency.
These macro changes are driving retail pharmacy to develop new strategies, moving away from business practices developed during the years of operating in a regulated environment with generally favorable trends.
Pharmacy Strategy in a Regulated World
Because there was seen to be a public interest in health care delivery, pharmacy was established in virtually all countries subject to regulatory and operational standards that generally were accompanied by restrictions on ownership, entry, and competition. As economies and medicine developed, pharmacies were able to take advantage of this environment and build profitable enclaves with limited competition. Even in the United States, the development of chain drug stores was largely regional in nature until the 1980s. Overall, within each country, pharmacy retail was characterized by similar-sized businesses, with similar organizational structures, offering similar products and services, and producing similar operational and financial results.
Following similar strategies meant that pharmacies competed mostly on location/convenience and by claiming to provide better quality (in practice, these differences were perceived to be quite small – pharmacies have long been among the most trusted retail formats). Eventually, costs and productivity became second-order concerns, while overall market growth and the rise of new long-term medicines drove dispensary volumes and profits up. The capitalized value of drugstores grew markedly.
This environment led to competition within the club, with pharmacies becoming inwardly focused, defining markets and operations in terms of what they did, rather than in terms of what the customer might want or need. This approach was viable as long as markets were limited by regulatory or implicit geographical constraints. Indeed, favorable demographics and the development of medicines for chronic conditions (cholesterol, hypertension) allowed this industry structure—and pharmacy profitability—to persist in many countries.
In contrast, the relatively open market in the United States led to large-scale entry by supermarkets and discount department stores into pharmacy and OTC medicines. This new competition spurred a wave of consolidation resulting in three major national drugstore chains by the early 2000s (Walgreens, CVS, and Rite Aid), as well as three large wholesale organizations (Cardinal, AmerisourceBergen, and McKesson), each linked to a network of affiliated independent owner-operator pharmacies.
The Effects of Liberalization/Deregulation
Pharmacy deregulation has tended to take place on a gradual basis, through liberalizing ownership and operating restrictions. The main exception to this was in Sweden, where the government had previously operated a monopoly system, Apotek.8 Sweden’s 2009 decision to liberalize thus required both substantial privatization and a shift from government ownership to regulated pharmacies. The government retained about one-third of the pharmacies to ensure continued service in rural areas; the remainder was sold in clusters to a variety of private equity groups. This divestiture was accompanied by lowered restrictions on new entrants (pharmacists have to operate the dispensary but do not have to own the business), resulting in about 15 percent new pharmacies. Restrictions on the sale of OTC medicines also were lowered, spurring more competition by established mass market retailers. In effect, Sweden is in the midst of a wholesale change in pharmacy retail.
Phased liberalization has given pharmacies in most countries a window of opportunity to develop sound retail strategies. These strategies should take into account the economic and competitive changes that are occurring, including9:
- Unlike the old world, deregulation means you tend to get new entrants with new strategies (and, also, with no legacies to deal with!) New entrants often target specific customer segments, such as the price-driven consumer, by starting warehouse-type models. But, the low-price volume driven drugstore requires low costs and scale, which means that many of these new entrants will fail. In pharmacy retailing, there appears to be only a limited market for heavy discounters, with very few players in the long run.
- Technology also can drive entry (especially through online activities), but these new/emerging channels are often best adopted by incumbents willing to be smart and flexible. (A good example is Walgreens’ acquisition of drugstore.com in 2011.) However, incumbents slow to move into these new channels will likely be at a disadvantage in the long run.
- Incentives to control costs and to improve productivity are not just driven by discounters or technology. Deregulation has generally meant that prices fall faster than costs, so margins are squeezed. As discussed above, this will be especially true in pharmacy, as core dispensary reimbursements from governments and third-party pharmacy benefits managers (PBMs) are falling dramatically.
- The increased financial pressures will put more pharmacies under financial strain, with external capital funding becoming less available and carrying harsher terms. An increase in bankruptcies is likely, spurring industry consolidation.
- Industry consolidation also will take place through increasing mergers and organizational affiliations, with a need to rethink traditional organizational boundaries. Both scale and scope economies become more important. As a result, becoming part of a pharmacy network has much more value, spurring deepening franchise models which can link suppliers, wholesalers, and retail pharmacies.
One of the leading thinkers on strategy, Michael Porter, has suggested that there are three generic strategic positions: focused (niche) strategies; cost leadership; and differentiation.10 How might these approaches play out in pharmacy retailing?
Focused (niche) strategies can be successful when there is a limited, but highly profitable market with high entry barriers. The old world of pharmacy retailing was perhaps the classic example, because the profitability of the dispensary was almost self-supporting. Any other front-of-shop activities were incremental to business success and profitability. But, in the new world, the role of the dispensary is shifting from profit driver to traffic driver—with low profitability and the need to build a more complete retail model. Another focused strategy might be to concentrate on the premium segment. As appealing as this might be in the abstract, this has not been a big a segment as many imagined. In practice, strong differentiated competitors (see below) have been able to construct premium offers that reduce the strategic opportunity. In sum, focused strategies will be very challenging in the drugstore industry.
Cost leadership strategies have driven many retail sectors in recent years (for example, Walmart and Amazon). It is important to recognize that you cannot have a large number of cost leadership players, since a successful strategy requires volume and scale. This almost inevitably results in only a few players in the end. In pharmacy retail, each country/market is likely to have only one or two successful discount drugstores.
Moreover, research suggests that pharmacy customers choose their pharmacy most often because of location/convenience and then brand/chain. Only 20 to 25 percent report that lowest prices are the reason they shop most often at a particular pharmacy. (It also is worth noting that knowledge/trust is not a primary driver of shopping behavior, but this appears to be due to the overall high level of trust in drugstores relative to other retail sectors.)
Given the large number of pharmacies and the inherent limitations of focus or cost leadership strategies, differentiation strategies would appear to offer the most appeal. But, in order to be successful, these strategies must be truly differentiated in the mind of the customer. Because of the dispensary, pharmacy retail has a good starting hand to play in a differentiated offer. The need is to extend that difference to other categories, such as health and wellness, or beauty. While these categories have more extensive competition, they also tend to be product- and service-driven—characteristics that are clearly applicable to pharmacy retail. But, such differentiation also requires exclusive, first-to-market, or private label products that are not available to mass merchants, which, in turn, requires access to global suppliers and networks. (An example of this is the No. 7 cosmetics lines offered by Boots Pharmacy.) In the longer term, pharmacy retail may have the opportunity for differentiation through the provision of health care services such as immunizations or on-site clinics.
The best differentiated offers have built strong brand equity. These brands stand for a strong image, and they deliver on a consistent basis across the store and multichannel networks. In pharmacy, this is likely to require good upstream partnerships with suppliers and wholesalers, and good downstream value for customers. Given the historical trust relationship with customers, pharmacy retailing has an exceptional opportunity to help navigate the complex and exploding categories of health and beauty—in effect becoming a curator and interpreter for the customer. To do so, however, requires that pharmacy executives treat these categories as core business, not add-ons or afterthoughts.
Summing Up: Six Challenges for Pharmacy Retailing Executives
- Think. If you don’t have a strategy, you will be given one. (And, you probably won’t like it!)
- Think bigger. Your strategy needs to take into account the sea changes in global pharma, government health policy, demographic shifts, and macroeconomic pressures.
- Think smaller. Your strategy needs to take into account your trusted connection to customers in health care and related categories on a 1:1 basis. As Walgreens states, seek “global reach with local relevance.”
- Think longer. There is always a tendency to focus on the short term. Decisions need to be put in a broader, longer-term context. Remember that changes from one period to the next can easily be missed or explained away, but changes over the endpoints are devastating.
- Rethink never. The boundaries of pharmacy retail are being redrawn, with new opportunities, new organizational forms, and new ideas.
- Think again. All retail cycles are getting faster, including retail strategy. Retail pharmacy is replete with examples of companies getting into trouble because they failed to reinvent themselves.
- For a more complete discussion of national and regional differences in pharmacy, see R. Lowe and D. Montagu, “Legislation, regulation, and consolidation in the retail pharmacy sector in low-income countries,” Southern Medical Review, Vol. 2 Issue 2, September 2009, pp. 1-10; D. Macarthur, “Pharmacy Liberalisation in Europe: Prospects and Implications,” (Edina, Minnesota: Arrowhead Publishers, 2008.)
- See R. Lowe and D. Montagu, “Legislation, regulation, and consolidation in the retail pharmacy sector in low-income countries,” Southern Medical Review, Vol. 2 Issue 2, September 2009, pp. 1-10.
- H. Shaw, “Analysts see negative impact in generic drug pricing changes on Shoppers Drug Mart,” Financial Post, January 21, 2013, available at http://business.financialpost.com/2013/01/21/analysts-see-negative-impact-in-generic-drug-pricing-changes-on-shoppers-drug-mart/
- J. Chave, “The Structure and Performance of Community Pharmacy in the EU Member States: Strategic Challenges and Successful Innovations,” presentation to API Conference, Barcelona, June 2011.
- R. Buckeldee, “Global Opportunities of Rx to OTC,” (New York: Nielsen, May 2010).
- Data in this section are reported in D. Bloom et al., “Population Aging: Facts, Challenges, and Responses,” Harvard Program on the Global Demography of Aging Working Paper No. 71, May 2011, available at http://www.hsph.harvard.edu/pgda/WorkingPapers/2011/PGDA_WP_71.pdf
- Data from this section are reported in H. Kharas, “The Emerging Middle Class in Developing Countries,” OECD Development Centre Working Paper No. 285, January 2010, available at http://www.oecd.org/dev/44457738.pdf
- See Business Monitor International, “The Pharmaceutical Market: Sweden,” (London: Business Monitor International, 2012.)
- For additional discussion, see FitzgeraldPower and TouchStore, “Retail Pharmacy Benchmarking Study 2012,” available at http://www.fitzgeraldpower.ie/uploads/publications/2012_Retail_Pharmacy_Benchmarking_Study.pdf; and A. Fein, “2012-13 Economic Report on Retail, Mail, and Specialty Pharmacies,” available at http://drugchannelsinstitute.com/products/industry_report/pharmacy/
- See M. Porter, “What is Strategy?”, Harvard Business Review, November-December 1996, pp. 61-78.