Thursday, May 10, 2012

Walgreens is Losing Its Battle with Express Scripts

Last week, Walgreen (NYSE: WAG) reported another month of dismal sales following its exit from the Express Scripts (NASDAQ: ESRX) pharmacy network. See Walgreens April Sales Decrease 3.7 Percent.

The chart below highlights the ignominy of watching Rite Aid (NYSE:RAD) grow more quickly than Walgreens. That must hurt. Last December, Walgreen’s management presented rosy scenarios in which they retained as much as 70% of the Express Script’s business. My back-of-the envelope calculations suggest they actually retained about 15%.

Walgreen’s management is hoping for an unlikely miracle during the PBM selling season. When that doesn’t happen, expect some executive heads to roll and a deal to be made.

AND IT’S NOT EVEN 12/21/12 YET

The dispute began last June when Walgreens issued an odd press release announcing its plan to exit from the Express Scripts network. See Walgreen and Express Scripts Play Chicken. Express Scripts used the six-month (!) lead time to communicate excessively and directly with its plan sponsor clients. At the time, I assigned a 15% to “no agreement.” Oops.

For Walgreens, 2012 is starting to look like an early apocalypse. Here’s a look at the year-over-year change in same-store prescription revenues at Walgreens, Rite Aid, and CVS Caremark’s (NYSE: CVS) retail stores. (Note that CVS only reports on a quarterly basis, so I simply plotted the quarterly figure in each month for comparison.)

Yikes! CVS Caremark CEO Larry Merlo must have sent a fruit basket to Greg Wasson because, in the first quarter of 2012, the kerfuffle shifted 5.7 to 6.5 million prescriptions from Walgreens to CVS. DOH!

According to Walgreen’s press release:
The negative impact on comparable store prescriptions filled due to no longer being part of the Express Scripts, Inc. pharmacy network was 10.7 percentage points. Prescriptions processed by Express Scripts comprised 12.6 percent of Walgreens prescriptions in April 2011.
Combining these two figure suggests that Walgreens retained only 15% of the Express Scripts business. As recently as a December 2011 earnings call, Walgreens management projected a retention rate as high as 70%. Here's how they arrived at that hopelessly optimistic scenario:

Oops?

On the bright side, same-store prescription growth was positive, excluding the Express Scripts effect.

WHAT’S NEXT?

Many people, including me, are surprised that the dispute has lasted as long as it has.

Walgreens is clearly hoping that plan sponsors will pressure Express Scripts to cut a deal and keep the chain in the network. And as I note in Decoding the Clues to Express Scripts' Strategy, a small number of plan sponsors have been switching away from Express Scripts to keep Walgreens in their network. Most, however, appear to have accepted the change...for now. Here’s what Express Scripts wrote in its just-released Drug Trend report:
One retail pharmacy chain, Walgreens, was unwilling to offer rates and terms consistent with those of the market, and instead opted to leave our pharmacy network at the beginning of 2012… As demonstrated by our successful transition of members from Walgreens to other pharmacies in early 2012, most patients understand the broad access available to them.
Other PBMs, such as SXC, seem intent on keeping Walgreens, in part as a differentiation vs. Express Scripts. See SXC CEO Mark Thierer’s comments in The SXC-Catalyst Merger: Initial Thoughts On the Deal.

It’s not clear what Express Scripts has offered its plan sponsor clients to make them satisfied (and economically comfortable) with the network change. I also don't see how Walgreens can remain in the Medco network for much longer without cutting a deal to remain in the Express Scripts network. On a Citigroup conference call last week, JoAnn Reed, former CFO of Medco, explicitly forecast that Walgreens will exit the Medco network.

Express Scripts reports earnings after the market close this evening and will host its earnings conference call at 9:00 AM on Friday. (Listen here.) Tune in for Q&A on the Medco network and the Walgreens negotiations.

I’m less certain than ever that Walgreens can win this battle. And even if they do sign a deal, it will take years to recapture lost business. Many consumers are probably gone forever.

So, what is Walgreen’s board thinking? How far will they let this dispute go? And, which execs will be sacrificed to get the inevitable deal done, before Walgreens drives itself over a cliff?

BONUS

More than 10 years ago, Walgreens was anointed a "Good to Great" company, along with Fannie Mae and Circuit City. Here's a popular song from that golden era.

13 comments:

  1. Interesting perspective but is there really a strong reason for Walgreen's to rush to a deal?  The damage has already been done to Walgreen's while the PBM selling season is just underway.  ESRX will certainly lose some customers whether it's pharmacy network or merger related, we just don't know how many yet.

    Most PBM's have already squeezed out what they can from the channel and if both parties can put aside personal feelings and egos, at the end of this, hopefully they will realize that a race to the bottom on discounts will only drive business to their competitors. 

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  2. PhexpressMay 10, 2012

    Adam,

    Your writing style is still great entertainment. Love the phrase "back of the envelope calculations". Hate to say it, but that's how many small guys run their operation.

    No doubt that heads will roll at the WAG -- both at top and mid management. Too many folks doing too many foolish things.

    I tell my kids everyday, "don't be a pig -- learn to live off of less". Our whole industry has learned this lesson, as have most others. And before you know it, so will WAG and all the PBM's.

    And that video...was that something from your college years?

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  3. Adam,

    Here is my theory.  I would be interested to hear your thoughts.  Express Scripts will eliminate Walgreens from their networks (including the Medco clients) entirely.  This will hurt Walgreens financially and result in further declines in prescription sales (following the trend in your chart).  Express Scripts will then slide in and purchase Walgreens and then be in a position to compete with CVS/Caremark by having the full array of service offerings (their own pharmacy network/PBM/mail order/specialty). 

    There is something grossly wrong with our PBM industry and the conflict of interests are growing day by day.  How can a PBM manage a benefit for an employer/govt group and pay themselves as a provider (specialty/mail/retail) within their own network. 

    Why is this bad business and not in the best interest of the employer/govt group funding this?  Because the PBM maintains artificially high MAC rates and drug ingredient cost discounts laden with profit for themselves.  The FTC needs to re-look at this again and break apart this nonsense. 

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  4. Alas, I graduated from college in the 1980s, so I could have gone with this video describing a Walgreens management meeting.

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  5. I'd be shocked if Express Scripts' current management tried to acquire WAG.

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  6. Matthew CoffinaMay 10, 2012

    Hey Adam,
     
    Any thoughts on how to reconcile WAG’s 15% script retention with ESRX’s 95% of clients moving forward without WAG in-network? I can only think of two things:
     
    the 5% of clients that left or struck a side deal with WAG are especially heavy utilizers of WAGsome continuing ESRX members becoming cash-pay WAG customers (prescription savings club, etc...)
     
    Thoughts? Is that enough to explain 10%?
     
    Best,Matt

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  7. My thought process tells me that all business moves being made by Walgreen’s top executives today and in the near future are solely to position their company in such a manner that never again can a PBM exclude them from a contract without doing substantial harm to the PBM involved. Or they are silently panicking waiting for the next opportunity to sign an EXP contract.
    Point One:
    Walgreens as a stand-alone chain is not big enough to inflict such harm, the other major chains refused to collaborate with Walgreen against Express, most likely in hopes of gaining some WAG market share for themselves.
    This leaves only the Independents as possible WAG ally to create this network monster that a PBM could not kick out without harming the PBM itself.
    HOW does a mortal enemy of Independent Pharmacist create a non-threatening image to try and induce enough independent pharmacists to join a Walgreen’s network to prevent an Express Script lock out of WAG in the future? Ironically Independent could create such a network (but don’t)  without WAG but WAG cannot a create such a network without independent pharmacy joining in.
    RxAlly and Bruce Roberts are their attempt, using Disease management and MTM as bait where effective and Rx distribution when that is effective bait.
    No terms, no dollars, no business structure, no hierarchy delineated, no spatial relationship defined between WAG and the independents, no business model of any ilk, only a vague promise to sign with Rxally and Walgreens and these principles will take care of us, the independents later.
    Point two: Point one will not work and WAG will sign with great panic the next EXP and Medco contracts they are presented with.
     Additionally; Walgreen and RxAlly are 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?
    Jim Fields RPh
    CFO ApproRx

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  8. Matthew CoffinaMay 10, 2012

    Hey Adam, Any thoughts on how to reconcile WAG’s 15% script retention with ESRX’s 95% of clients moving forward without WAG in-network? I can only think of two things: 1) the 5% of clients that left or struck a side deal with WAG are especially heavy utilizers of WAG
    2) some continuing ESRX members becoming cash-pay WAG customers (prescription savings club, etc...)
    Thoughts? Is that enough to explain 10%? Best,
    Matt

    ReplyDelete
  9. To top it all off, Walgreens is losing a key ally in this battle --- their own employees through what pretty much amounts to bullying and intimidation tactics.  The stores' employees are the ones who corporate is relying on to make up the difference through inane programs and slogans.  Anyone not "making the numbers" get their necks stomped on by the "jack booted thugs" from the district office and above.   And if this is not enough the management structure sytem in the stores is undergoing the most extensive change (much to the detriment of every management level in the stores) in the history of this company. 

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  10. I agree with your 2 points. A third factor: payers that have switched PBMs to retain Walgreens in the network. I'm not sure which of these are public, so I can't name them on the site.

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  11. Sales were down, but how were the profits?

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  12. Key points:
    1.       There is no evidence, and it is likely not true that if Walgreens accepted ESI’s terms, clients costs would have been less..only ESI increasing margins and profit
    2.       Spread Spread Spread
    3.       Oh, and spread…..

    Go to this link and then let's disuss how this happens - really happens.

    http://www.washingtonpost.com/business/express-scripts-shares-climb-after-pharmacy-benefits-manager-details-1st-quarter-growth/2012/05/11/gIQAVQKCIU_story.html
     
    Unlimited revenue source…..spread pricing

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  13. hey adam,
    A little off topic here. Last year there were a few articles written about a possible cvs caremark split up, including yours on drug channels. You stated after march of 2012 it would make sense from a tax purpose standpoint. After the esrx purchase of mhs do u still feel cvs crk may still split or  can you share your analysis of their hum happy conference calls saying all is dandy with crk. Seems their magins on the pbm side are draining them dry while retail is incrementally more positive based on wags vs esrx. thanks for ur input

    ReplyDelete

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