Walgreens, Mass Closures, and the Power of Incentives

Commentary

Headlines about Walgreens closing 1200 stores over the next few years are making waves across the United States as anxious store managers wonder if their location will be next. According to an earnings release report from Illinois-based Walgreens Boots Alliance, the firm plans to finalize a “significant multiyear footprint optimization program.” A program that seems sorely needed given recent reports of $3 billion loss. In September, Walgreens stock hit a multi-decade low and “weak margins, persistent profitability issues, and a heavy debt load” were all noted as major problems for the firm.

Despite Walgreens being ranked as one of America’s most trusted brands, with a rich history dating back to 1901, 500 stores are slated to shut their doors in 2025 with more closures to come in the years following. And Walgreens isn’t the only pharmacy facing troubles, Rite Aid filed for bankruptcy in October 2023. So, with this in mind, let’s take a high-level look at what is ailing the pharmacy sector and why we all should be mindful of the meaning behind such store closures.

It’s the Economy Stupid

Walgreens is more than a pharmacy; it’s a retail store where you can grab shampoo, snacks, milk, and magazines. Walgreens doesn’t compete on price with the likes of Walmart and Costco, who leverage scale economies, rather it relies on consumers who are willing to pay more for local convenience. However, thanks to door-to-door and same-day deliveries, the convenience aspect of small neighborhood retailers is less valuable today and, in the present inflationary environment, consumers have become increasingly price sensitive. Even when waiting for a prescription to be filled, consumers would rather kill time by shopping online via their phones instead of browsing store aisles.

In-store sales matter for Walgreens since it enables opportunities for cross-subsidization, whereas profits from purchased consumer products can be re-allocated toward overall operational expenses. Cross-subsidization is a common practice in the business realm—for instance, airlines subsidize the costs of economy seating with the price of first-class tickets. And it is well known that pharmaceutical manufacturers rely heavily on the success of one drug to supplement the costs of development and the trials of other drugs.

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In short, Walgreens can’t shoulder inflationary operational costs without in-store sales; and consumers can’t shoulder the convenience premium Walgreens charges in the current economic environment. The consumer shopping component, however, is only one of several factors giving Walgreens trouble.

Incentives Matter–Always

Over the past few years, enrollment in pharmacy schools has gone down while pressures for the profession have gone up—particularly during the pandemic. Pharmacists work long hours, sometimes alone, and can face unhappy and unwell customers. But, the real issue pharmacists have been facing is the dwindling of drug reimbursement rates thanks to the rise in power of Pharmacy Benefit Managers (PBMs).

PBMs got their start in the 1960s when both health benefit plans and prescription drug options increased. Rather than patients paying for a prescription and then submitting a claim to their insurer or employer to process, PBMs stepped in to handle this administrative matter. But, as time went on, PBMs expanded their role beyond processing claims and facilitating reimbursements to determining what drugs should even be considered for coverage and reimbursement on health plans.

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“PBMs work in conjunction with drug manufacturers, wholesalers, pharmacies, and health insurance providers but play no direct role in the physical distribution of prescription drugs, only handling negotiations and payments within the supply chain. When a new drug is available, the manufacturer negotiates with wholesalers who then sell and distribute drugs to pharmacies. PBMs negotiate agreements with drug manufacturers on behalf of insurers and are paid rebates by drug manufacturers.”

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The incentives for PBMs, in addition to drug manufacturers, are to have higher priced drugs on healthcare plans since the higher the price, the bigger the rebate for the PBM. And, given that patients will go with whatever drug is covered by their health plan, drug pricing can (and has) run amok.

The Medicare Market Mess

Although PBMs have been around since the sixties, it wasn’t until the 2000s that prescription prices started skyrocketing. And, as with many things, government involvement is what inflated this mess.

In 2003, President George W. Bush signed the Medicare Prescription Drug, Improvement, and Modernization Act which applied Medicare coverage to outpatient prescriptions that were previously not covered. The passing of Medicare Part D, in 2006, resulted in a substantial captive market made up of Medicare enrollees in need of prescriptions to be processed through Part D plans. And since PBMs were tasked with not only processing claims but also the negotiation of drug prices on those plans, drug companies sought the favor of PBMs, not patients, in order to capitalize on Medicare payments. So, as the 2000s progressed, so too did the prescription drug market and prescription prices.

One of Walgreens competitors, CVS, had the foresight to adapt to the change in market dynamics and acquired Caremark, a PBM, in 2007. Today, CVS is in a better position (albeit not stellar) when compared to Walgreens because of its PBM rebates as well as its pursuits to play a part in drug manufacturing.

In 2023, CVS unveiled its new subsidiary, Cordavis, as a way to vertically integrate the commercialization of certain medications in response to the growing competition from alternative pharmaceutical services like Mark Cuban’s Cost Plus drug program. This move comes as CVS prepares to address drug price hikes and changing market dynamics.

The closure of Rite Aid and Walgreens stores has raised concerns about the emergence of pharmacy deserts, where access to essential pharmaceutical services is limited or nonexistent. This issue is particularly problematic for individuals who rely on nearby pharmacies for urgent medication needs. The convenience of having a pharmacy within close proximity is crucial, especially for elderly patients or those with transportation limitations.

While online fulfillment and delivery services offer alternative options, the personal touch and expertise provided by in-person pharmacies cannot be easily replaced. Pharmacists play a vital role in ensuring proper medication usage, addressing concerns, and providing additional healthcare services beyond just dispensing prescriptions.

As the population ages and pharmacy closures continue, the rise of pharmacy deserts presents a significant challenge. However, companies like Dollar General have stepped in to repurpose vacant pharmacy locations into DG Markets, offering fresh produce and essential goods. While Dollar General currently does not provide prescription services, their expanded health and wellness offerings may help alleviate the impact of pharmacy deserts in some communities.

The ongoing challenges faced by traditional pharmacies underscore the need for innovation and adaptability in the healthcare sector. Telehealth services and direct-to-consumer drug options are expanding, offering new avenues for prescription access. Encouraging creativity and flexibility in the pharmaceutical industry can help address pricing issues and improve overall healthcare delivery.

Despite the pressures faced by Walgreens and other traditional pharmacies, strategic decisions to optimize resources and adapt to market changes are essential for survival. While store closures may be necessary, agile brands and leaders can navigate these challenges more effectively than rigid bureaucratic systems. Embracing entrepreneurship and market-driven solutions is key to ensuring a sustainable and efficient healthcare system. Please rephrase.

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