Sunday, February 22, 2009

CVS Caremark: No Visible Revenue Synergy

Can two different businesses share a company without driving each other crazy?

Or as I asked in my Ten Strategic Questions for 2009: “Will CVS Caremark finally prove the strategic value of a Pharmacy Benefit Manager/Retail Pharmacy combo?”

So far, the answer appears to be “not yet.”

I won’t do a deep dive into the company's finances or strategy on the blog (sorry, clients only), but CVS Caremark posted impressive financials in its 2008:Q4 earnings last Thursday. Same store sales at CVS retail pharmacies increased 4.5% in 2008 (4.8% in pharmacy and 3.6% in the front-end). The Longs deal gave an extra boost to fourth quarter revenue. Last week's top-line results shouldn’t be a surprise if you read last Tuesday’s post Pharmacy Avoids Retail Sales Plunge. See:

However, CVS Caremark’s PBM businesses are not becoming a larger share of prescriptions filled at CVS retail pharmacies. Put another way, the flagship Maintenance Choice program may be appealing to payers and consumers, but there is not yet a quantitatively visible shift in CVS' retail activity. If CVS pharmacies are taking retail pharmacy market share, then it’s not yet as a result of corporate co-ownership with a PBM.

Looking forward, I suspect that CVS Caremark will try to take a stronger hand to generate greater “synergies” for its combination business model. CEO Tom Ryan alluded to "people experimenting with limited networks" on Thursday's earnings call. Wal-Mart has already thrown down the gauntlet for the preferred pharmacy network in its deal with Caterpillar. (See WMT + CAT: Pharmacy's Future?.) However, we still have little evidence that consumers or payers will accept limited networks on a wide-scale.

The Numbers

Here are the numbers behind my observations about PBM revenue synergies at retail pharmacies

Since 2005, CVS has reported an income statement item in its SEC filings called “Intersegment eliminations,” which is currently defined as follows:

“Intersegment eliminations relate to intersegment revenues and accounts receivables that occur when a Pharmacy Services Segment customer uses a Retail Pharmacy Segment store to purchase covered products. When this occurs, both segments record the revenue on a standalone basis.”

Thus, these eliminations are a proxy for measuring the revenues to CVS retail pharmacy when it fills a script for beneficiaries of a CVS-owned PBM plan. As I understand the accounting, a PBM usually recognizes revenues for these prescriptions because the PBM considers itself to be a principal in the transaction. The relevant PBMs are Pharmacare, Caremark (starting in 2007), and now RxAmerica (starting with Q4:2008).

The chart below shows quarterly intersegment eliminations as a percent of retail pharmacy prescription revenue during the last three years. Thus, the chart shows an estimate how much of CVS' retail prescription revenues come from CVS Caremark’s 3 PBM businesses.

As expected, the numbers jump sharply after the Caremark acquisition. But it’s notable that the share has not consistently increased since the acquisition. If the in-store share starts to rise, then it will be (partial) evidence that maintenance choice is getting traction. (One small twist: RxAmerica contracts will be moving from "net" to "gross" in Q2:2009, which will boost intersegment eliminations.)

In the meantime, I suspect some readers will view this disconnect in a positive light because it means that beneficiaries still have the freedom to choose their pharmacy regardless of co-ownership with a PBM.

So, which one is the neat freak and which one is the slob?


  1. Dr. Fein:

    Good morning, as a frequent reader of your blog, I’ve greatly appreciated just how much you gone at length to explain many of your arguments and calculations

    However, concerning today’s post, I notice you didn't describe how you came up with the % of Rx sales at CVS retail pharmacies that came from Caremark's PBM business.

    I was wondering if you might be willing to provide the details as to how you came up with these numbers?

    Thanks again for the posts

    David Sleeter

  2. David,

    The data in the chart are computed using the following formula (quarterly data):

    Intersegment eliminations /
    [Retail Pharmacy Segment revenues X Pharmacy as % of Retail Revenues]

    If you are a GLG client, feel free to schedule a call and I can provide more details on the assumptions and caveats behind the calculation.


  3. Adam, PBM/Pharmacy items aside, I found the increase in Pharmacy sales interesting, especially with the concerns about $4 generics, etc. Also, the increase in Pharmacy sales vs. front end sales was also interesting! Pharmacy increase MORE. Pretty interesting considering the space allocated to each. What is the profit for front end vs. pharmacy?


  4. At our pharmacy (small chain), we usually offer to match prices rather than lose a customer. We have not lost anyone to CVS and have seen no change in business after the caremark merger. We run PBM contracts through our wholesaler so that may be protecting us for now.

  5. Maintence Choice is essentially a 90 Day retail option for members of a Caremark plan only at CVS with the same 2-times co-pay as mail.

    It begins to define CVS as a preferred provider of Caremark.

    In most cases, this would mean a shift in a fill from Caremark mail to CVS retail -- and increase the "intersegment eliminations"

    However, it should be remembered that management of the pharmacy benefit segment Federal Employee Health Benefit Plan (FEP) is split between Caremark managing retail and Medco managing mail.

    To the extent that Caremark targets Maintence Choice at FEP members, especially in the Beltway where CVS is dominant, this would result is a pure win for CVS-Caremark and not a "intersegment elimination"

    Targeting FEP members with a 90 day retail option is a very important step in realizing some of the revenue synergies promised by the CVS_Caremark merger.

    None of the Wall Street analysts that cover the PBM space has mentioned this in any CC.

    Don't be too quick to dismiss the potential of Caremark offering 90 retail only to its members it it gets filled by CVS.

    The trend toward 90 day retail is a real threat both to Medco, Express Scripts.

  6. Thank you for your detailed and thoughtful comment.

    I am certainly not dismissing "the potential of Caremark offering 90 retail only to its members it it gets filled by CVS." In fact, I believe that this preferred/restricted network model will be coming to retail pharmacy. See my comments about CVS Caremark in WMT + CAT: Pharmacy's Future? or my comments from early last year about Wal-Mart's PBM Game Plan.

    I still believe that there is a profit tradeoff when a consumer shifts from a low cost-of-dispensing mail channel to a higher-cost-of-dispensing retail channel. Mr. Ryan pooh-poohed this notion on the earnings call, but I am not yet convinced.


  7. CVS Caremark has been very clear that the profit comparison of 90-day at retail vs. 90-day at mail should be viewed only on a marginal basis and not a full cost basis. This seems to imply that there is excess pharmacy capacity at all or most of the CVS pharmacies, or the economics would not work. They have also said that mail volumes may continue to grow as they encourage customers who do not have Maintenance Choice to use mail, but if there are declines Caremark can cut variable costs at their mail order facilities. They believe that a higher proportion of costs are variable at mail order than at retail.

  8. As a current CVS Caremark employee, I can tell you that we all feel that the long-term goal of CVS is to use mail service as a feeder to the retail stores. In other words, continue to acquire new clients using the mail benefit as part of the attraction, then once they're CVS Caremark clients, promoting the shift to the retail stores (and their hairspray and deodorant, etc), through the Maintenance Choice program. Most of us on the PBM side feel as though we're the "raw materials" for this new product model. Thanks.

  9. Maintenance Choice appears to be the CVS equivalent of WAGs Advantage 90. That said, I'm a member of a state high risk pool plan that uses Health Care Service Corp as 3rd party administrator. Thankfully, the plan does not use HSC's sucky (technical term) PBM Prime Therapeutics - it uses Walgreen Health Initatives. I am luckier still that I can get my WHI Advantage 90 prescriptions filled at CVS rather than at WAG.WAGs nasty stores seem to attract nastier employees.