Wednesday, June 25, 2008

Walgreens’ $4.33 Surrender to Wal-Mart

Walgreens (WAG) has begun touting its Walgreens Prescription Savings Club, which offers a 3-month supply of over 400 generics for $12.99 (plus an annual membership fee). “That’s just over $4 a month” screams the promotional literature. (It’s $4.33 per month for math geeks.)

Walgreens latest move suggests that the low-priced generic wave is having a bigger effect that many people (including me) expected. It also means that competition in the private sector is now removing generic margin from the channel much faster than an Average Manufacturer Price (AMP)-based FUL ever could have.


When Wal-Mart (WMT) launched its $4 generic drug program in September 2006, I wrote the following in Wal-Mart's Generic Pricing Will Trigger Big Changes: “Folks, we are witnessing a triggering event in real-time. I think Wal-Mart’s move will create massive change in the U.S. pharmaceutical distribution system because it threatens our current system of cross-subsidization.”

Non-pharmacy chains followed Wal-Mart’s move – Target, Kroger, Safeway, Giant Food, et al. These retailers have been able to absorb lower generic margins because pharmacy represents a minority of their sales and gross profits.

Non-pharmacy chains are taking advantage of the high generic margins embedded within in the traditional pharmacy business model, especially for cash-pay customers.
If you don’t know what I mean by “cross-subsidization,” click here to read my post from May 2006 in which I predicted this outcome.

Here are my three most recent analyses of Wal-Mart’s generic drug strategy: WALGREENS REACTS

Like many people, I’ve believed for some time that chains such as
CVS Corp (CVS) or Walgreens (WAG) were not especially vulnerable to Wal-Mart’s (WMT) $4 generic program because customers with third-party insurance do not save much versus standard co-pays. Walgreens was so confident in its own business model that it issued this Statement On Wal-Mart’s Promotional Drug Pricing in October 2006:

“Walgreens will not match Wal-Mart’s promotion. Once consumers learn the fine print of Wal-Mart's program, they'll realize Walgreens offers the best value for pharmacy patients with its convenient locations, close-in parking and unique pharmacy services.”

But on Monday’s earnings call, Walgreen President Gregory Wasson recanted, stating: “Discount retailers and grocery chains are picking up their pace of promotional pricing, especially in the pharmacy, which they’re using to build traffic.” Hence the emphasis on the new savings card, albeit with the requisite positive spin about convenience, service, brand, yada yada yada.

Overall, Walgreens still looks like a very strong company. The convenience factor is surely higher than Wal-Mart for most consumers. But I wonder whether Walgreens is throwing in the towel too soon simply because we are in a generic drug lull. I also note that Walgreens is aggressively (and sensibly) diversifying away from its core retail pharmacy roots.

Unfortunately, it’s very difficult to assess the true impact of $4 generics because Walgreens provides almost no public disclosure about its generic volume and margins. (Pet peeve: Despite representing 70%+ of pharmacy revenues, pharmacy chains mysteriously still consider financial data about the retail prescription business to be “not material.” Yeah, right.)


Most pharmacists have been fretting about reduced generic margins for Medicaid scripts if the Average Manufacturer Price (AMP) rule ever gets implemented (and cheering every legislative victory.) But Walgreens' move signals that competition among pharmacies is now removing generic margin dollars from drug channels much faster than AMP. I suspect that Pharmacy Benefit Managers (PBMs) will be worried by Walgreens decision, too.

I have been trying to warn pharmacists for the past year that AMP is NOT the single biggest threat to the survival of independent pharmacies or to generic script margins. The pharmacy shakeout is coming, but don’t put all the blame on CMS.


  1. AnonymousJune 25, 2008

    Are any of these $4 scripts being run through a customers insurance plan?

  2. AnonymousJune 25, 2008

    I don't quite understand why we aren't talking about PBM transparence, or the high profits of the Drug manufacturers. Their profits are much higher than any retail drug store.

  3. AnonymousJune 25, 2008

    One thought..

    What happens when the generic distribution channels decide they have lowered prices too much? By simply raising prices to a level where Walmart's (or anyone else in the game) cost of goods is more than the $4.00 retail? Plausible??

    Is Walmart then going to buy all of the generic manufacturers??

  4. AnonymousJune 25, 2008


    Do a viewpoint of what you think the retail distribution channel will look like in 5-7 years. Will we have any stand alone phamacy locations owned by small business ?? You have commented about the "shakeout" that is coming but could you be a little more descriptive??

  5. AnonymousJune 25, 2008

    Every PBM contract I ever saw says the pharmacy will be reimbursed at contracted price or usual and customary price, whichever is less. So if the Super Duper Drug Barn is selling generics for $4.00, they are contractually obliged to charge the PBM the same $4.00.

    Several PBMs have sent out letters reminding pharmacies of that clause.

    Tom Connelly
    Sun Pharmacy

  6. As always, thanks to everyone for the comments.

    A few quick responses to the questions above:

    1) I did not discuss the profits of PBMs or manufacturers because the post is about the changing profit levels within the pharmacy industry. See Drug Channel Profits in the Fortune 500 for my perspective on comparative profits between different types of companies in drug channels.

    2) Tom C is correct in pointing out the U&C wins when it is below other reimbursement rates. See my February post The Price Might Be Right and its comments for more on this point.

    3) It's hard to generalize about the shakeout, but I do believe that independent pharmacies will survive. However, lower volume and less efficient independent pharmacies without a differentiated niche face a tough future. See my January post Pharmacy Profits & Part D.

    As of 9:30 PM today, this post is the second most read article in Drug Channels history. I must have struck a nerve!


  7. I don't even know where to start, but I will try to cover some areas that haven't been mentioned without rambling too much.

    U&C was mentioned. these new "membership" cards by walgreens get around this issue. they are actually issuing their own insurance plan for their generic list of drugs. they can still charge anything they want to the rest of the pbms and cash paying patients not enrolled into their membership plan. Financially this really helps to keep the bottom line intact better than the wal-mart philosophy (they don't use memberships). The biggest issue from this standpoint is PBM's allow pharmacists to see what other medications are being filled at other pharmacies. If these medications are filled through the membership program, they will not be seen on the persons electronic pbm file if they fill a prescription somewhere else. We can talk about cost savings with drugs, but a drug interaction that causes hospitalization because of a drug interaction not seen is a big hole in these new programs.

    the other thing to keep in mind is that these $4 rx's do effect gross margins, but if someone is on 6 different medicines they are not all on the list. Wal-mart will usually pick up the patients entire profile of medications. This will help to offset the low margin on the generics they are providing. Finally, everyone in pharmacy world knows that some of the worst service provided is from wal-mart. I don't know what their average sales volume was before the $4 program, but I'd wager that it was at the bottom compared to the rest of the chains. In other words they had nothing to lose.

    I guess I did ramble, but I would love to get adams thoughts on this.

  8. Re: the new comment added on Dec 22

    You are correct that the U&C of a pharmacy is not changed by these plans. In contrast, Wal-Mart's $4 plan does establish a new U&C for the generics on its list, which is why Wal-Mart may receive lower reimbursement from a third-party payer (such as Medicaid) than other pharmacies

    For more on this topic, see my post The Price Might Be Right and the comments below the post.