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KEY POINTS

  • CNBC reported in May 2017 that, according to sources “familiar with the company’s plans,” Amazon has held annual meetings to discuss a potential entry into the pharmacy business and has set up a team to investigate the prospects of entering the space.
  • More recently, the St. Louis Post-Dispatch reported that Amazon has obtained wholesale drug distribution licenses in 12 states in the US.
  • Amazon sells over-the-counter (OTC) medication and supplements on its US site and it began selling prescription medicine on its Japan site earlier this year.

Introduction

Amazon created quite a frenzy earlier this year with its acquisition of supermarket chain Whole Foods Market. The e-commerce giant is now doing it again as rumors whirl regarding its potential entry into the pharmacy sector. Amazon has not yet officially announced that it will enter the pharmacy business, but it has made several strategic moves that indicate it is likely to.

In this report, we examine the steps Amazon has taken to prepare for an entrance into the US pharmacy sector, what the company can do in the market, the current state of the sector and key players within it, the factors that will work in Amazon’s favor and the challenges it may face.

 

Signs of Amazon’s Pharmacy Ambitions: Strategic Meetings, New Hires, Pharmaceuticals on Amazon Japan and Pharmacy Licenses in 12 States

Although Amazon has not explicitly communicated its ambitions to expand into the pharmacy sector in the US, news website CNBC first reported the likelihood of it in May this year, citing sources “familiar with the company’s plans.” The sources privy to Amazon’s intentions said that the company has held annual meetings at its headquarters over the last few years to discuss its entry into the pharmacy trade and has hired a new general manager to lead a team and prepare a strategy for the expansion. Amazon has also been in contact with industry experts to advise on the move, the sources said. Citing another source, the same article indicated that Amazon has begun hiring people from the pharmacy sector.

Earlier this year, Amazon began selling medical supplies and equipment on its US site. And, according to an April 2017 report by The Japan Times, the company expanded its Prime Now delivery service in Japan to include drugs and cosmetics in April. Japanese shoppers can now buy certain categories of drugs on Amazon after approval by a pharmacist.

More recently, the St. Louis Post-Dispatch reported that Amazon has already acquired wholesale drug distribution licenses from at least 12 state pharmaceutical boards. The company’s application in the state of Maine is currently pending approval.

Amazon has declined to comment on these actions, but the lack of an official confirmation from has not held back industry reaction. In a move that many experts view as a safeguard against Amazon’s potential entry into the pharmacy business, CVS Health recently bid to acquire health insurer Aetna for $66 billion. But what path Amazon could take is still uncertain, as there are many stages in the drug retail supply chain that it could tap.

 

What Could Amazon Do in the Pharmacy Market?

There are several ways Amazon could conduct business if it were to step into the pharmacy market. The company could:

  1. Become an online pharmacy retailer: The most likely choice is for Amazon to sell prescription drugs online. It already sells OTC medications and health supplements on its US website. In addition, online pharmacies and mail-order pharmacies already exist in the US, and some of the larger pharmacy chains offer these options to customers, so Amazon might choose to compete with them.
  2. Become a wholesale distributor: Amazon has acquired wholesale drug distribution licenses in 12 states. If the company were to acquire licenses in the other 38 states, it could leverage its logistics operations and become a nationwide distributor of drugs to chain pharmacies, independent pharmacies, hospitals and health centers.
  3. Create independent Amazon pharmacies or in-store pharmacies at Whole Foods: Amazon could set up independent pharmacies or in-store pharmacies at the Whole Foods locations that it recently acquired, or make those stores pickup points for drugs ordered online.
  4. Acquire a pharmacy chain: Amazon could follow its acquisition of Whole Foods with an acquisition of a pharmacy chain. This would help eliminate much of the groundwork the company would have to do if it were to set up a pharmacy business from scratch, including acquiring licenses and hiring new staff.

Amazon has always been innovative in terms of delivering its services, creating various layers of price points and differentiating its offerings, which include the Prime membership program, the Prime Video streaming service and the AmazonFresh grocery service, to name a few. In the pharmacy space, the company could decide to offer prescription services to Prime members or create a separate offering that enables customers to regularly fill their prescriptions.

 

Breaking into a $450 Billion Business

Prescription drug retail is a significant sector in the US, dominated by a few large players, and it involves a complex supply chain. Drug sales have seen burgeoning growth in the US over the last few years, so it is not surprising that Amazon may choose to make a play in the business. Consumers and other healthcare payers in the US spent approximately $450 billion on medicines in 2016, and the market grew at a CAGR of 7.5% between 2010 and 2016, according to healthcare analytics and solutions company IQVIA (formerly QuintilesIMS). In 2016, 4.5 billion prescriptions were ordered in the US, up from about 4 billion in 2010, according to IQVIA.

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The spending totals above include prescription and insulin products sold via chain and independent pharmacies, food store pharmacies, mail service pharmacies, long-term care facilities, hospitals, clinics, and other institutional settings and exclude OTC products.

We expect four types of stakeholders to be affected if Amazon moves into the pharmacy business: large pharmacy retailers (the “kingpins”), pharmacy benefit managers (PBMs), independent pharmacies and retailers with in-store pharmacies.

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The Kingpins

The pharmacy retail business in the US is currently dominated by three major names: CVS Health, Walgreens Boots Alliance and Rite Aid. The table below is a snapshot of the power they wield in terms of prescriptions filled and prescription drugs sold. We represent their aggregate shares relative to the IQVIA market totals shown above.

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Based on these numbers, the top three companies combined command roughly 65% of market share in terms of prescriptions filled and about 47% in terms of prescription drug sales in the US. If Amazon does begin selling prescription drugs online, it will likely steal share from these companies.

The Mediators

PBMs are third-party firms that negotiate prices on behalf of health insurers and employers (including the government). If Amazon takes on this role, and is able to achieve better and transparent pricing to pass on to its customers, it could run other PBMs out of business.

Friendly, Independent Neighborhood Pharmacies

When Amazon has entered a new geography or product category in the past, traditional players have tended to feel some effects of its presence, and some smaller businesses have closed as a result of the e-commerce giant’s aggressive moves. If Amazon enters the pharmacy market, smaller community pharmacies may be similarly affected, especially if Amazon is able to offer a better range of products at lower prices, with home delivery.

Retailers with In-Store Pharmacies

Shoppers often like to combine errands, such as picking up a prescription while doing their regular grocery shopping. So, retailers that have in-store pharmacies, such as Walmart and Kroger, are likely to be affected if Amazon moves into the pharmacy business, especially if it offers a wide range of products online. If shoppers are able to complete all their shopping online, they may not feel the need to visit their closest Walmart or Kroger pharmacy.

 

What Will Work in Amazon’s Favor?

Amazon has a reputation for dominance across the markets in which it operates, whether in online retail or cloud technology services, and there are several aspects of its existing business that will work in its favor if it moves into pharmacy services:

  1. The scale of its logistics operations: Amazon has robust logistics and distribution operations across the US. The company could leverage the scale of its shipping operations to take prescription drugs directly to consumers.
  2. Its size: Amazon’s revenues in 2016 totaled some $136 billion. That figure was lower than CVS’s total revenues of $178 billion, but higher than Walgreens’ $118 billion (as noted above, CVS and Walgreens are the largest players in the pharmacy sector currently). Of course, Amazon’s revenues are spread across multiple categories, while CVS’s and Walgreens’ buying power is more concentrated in the health and beauty categories. However, Amazon has previously shown its willingness to invest large sums in markets it is determined to break into. For example, it has committed to investing more than $5 billion, and has already invested $2 billion, in its Indian e-commerce operations. So, if Amazon commits to the pharmacy business, it may, in time, compete at a level similar to CVS and Walgreens.
  3. Its goal to be “the everything store”: Amazon already offers a huge variety of products, from books to diapers to groceries to clothing, and consumers may be drawn to the additional convenience it could offer if it sells prescription drugs online. Retailers such as CVS and Walgreens also sell cosmetics and personal care items, which contribute about 20% of the companies’ total revenues. But with Amazon offering attractive deals on such products, shoppers would likely be willing to shop for everything they need online, including prescription drugs, and no longer see a need to go to a CVS or Walgreens store to shop.
  4. Its technological prowess: Amazon has been an innovator, offering customers Dash buttons that enable one-tap replenishment of popular products and Alexa-powered Echo speakers that allow voice ordering through a virtual assistant. Many consumers also have prescriptions that they must periodically refill, and Amazon’s technology, which supports reordering convenience, could put it ahead of other players in the pharmacy space.

 

Challenges that Lie Ahead

If Amazon enters the pharmacy business, the process may not be as quick or straightforward as its entry into other sectors has been. First, Amazon would need to comply with the many and stringent regulations that govern the pharmacy sector. To further complicate matters, federal and state regulations differ, and regulations also vary from state to state. Therefore, it may be some time before Amazon obtains nationwide regulatory approval, and if it hopes to take on industry giants such as CVS and Walgreens, it will need to compete nationally. Also, those varying state regulations mean that Amazon would need to offer different pharmacy services based on location, as some states limit the services that pharmacists can offer.

Apart from the regulatory barriers, there are also market barriers that Amazon would need to overcome. CVS and Walgreens have well-established brands, but Amazon customers would need to know that they could trust Amazon when it comes to buying prescription drugs. Many consumers who are familiar and comfortable with their neighborhood pharmacist may find that person more credible than Amazon.

Another challenge is that prescription drug sales tend to be low-margin sales, but setting up pharmacy operations requires significant investment in terms of obtaining regulatory and distribution licenses and establishing storage facilities. We crunched data from business intelligence tool S&P Capital IQ for 144 US firms across apparel retail, multiline retail, food retail, drug retail, and hypermarkets and supercenters to find the average margin for each segment. Drug retailers, on average, see lower gross margins and EBITDA margins than do apparel retailers, multiline retailers or food retailers, and lower return on capital and return on assets than do apparel retailers, food retailers or hypermarket and supercenter retailers.

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Considering what Amazon has achieved in terms of entry and penetration across diverse geographic markets, it is likely that it will pull out all the stops if it sees a lucrative opportunity in the pharmacy sector. CNBC reported that the company is likely to announce a decision by Thanksgiving, so we may know within days whether Amazon will soon be the newest competitor to CVS and Walgreens.

 

 

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