Will Caterpillar (NYSE:CAT) allow Wal-Mart (NYSE:WMT) and Walgreens (NYSE:WAG) to compete on price within the network?
If so, Caterpillar will reap even bigger savings than initially projected at the expense of pharmacy profits at Wal-Mart and Walgreens.
Why? As Caterpillar rolls out its preferred pharmacy network, it seems clear that almost all of the prescription drug market share will be split between Wal-Mart or Walgreens.
Consider two scenarios.
Scenario A: If the co-payments charged by a Participating Provider are fixed by contract, then there will be no price competition. Wal-Mart and Walgreens will compete on service, convenience and location. This is the traditional pharmacy industry model.
Scenario B: A Participating Provider can opt to charge lower co-payments in a bid to attract incremental traffic. The in-network co-payments are simply maximum amounts—Caterpillar Upper Limits (CUL), if you will.
If this is a CUL model, then fans of game theory (anyone?) will recognize a classic two-player Prisoner’s Dilemma with two basic strategies:
- Cooperate (Don’t Discount Co-Payments)
- Defect (Discount Co-Payments)
Either company can improve its market share position by discounting the co-payments, but at the cost of reduced per-prescription revenues (shown as “$ per Rx”). If only one company discounts (no competitive reaction), then it wins market share at the expense of the other but only has to discount a little bit as shown in cells B and C.
The dilemma is the temptation to defect, pushing both companies into cell D.
Given Wal-Mart’s historical behavior in retail markets, what do you think will happen?
How will Walgreens react? Here's an eye-catching quote on the future of cost-plus, direct-to-payer deals (source).
Hal Rosenbluth, president of Walgreen’s health and wellness division, said he’s discussing similar deals with about 50 companies. “It’s a new model,” he said. “What you lose in margin, you make up in volume.”