What is the cause of Walgreens and CVS retail pharmacies' struggles, and how are they addressing the issue?

• Pharmacy chains like Walgreens and CVS have shifted their focus from expanding their stores to closing hundreds of locations in the U.S. in order to improve their profits.
• Prescription drug reimbursement rates have been declining, while inflation and competition have put pressure on the front of the store.
• Although drugstores are crucial to the U.S. health-care system and are relied upon by millions of Americans, they may need to adapt and innovate.

Whenever Shriya Raghavan, a research associate based in Philadelphia, needs to pick up necessities like gum, deodorant and soap, the abundance of and stores makes them convenient.

Pharmacists often have to juggle tasks, which results in employees unlocking cabinets and lengthy lines for picking up prescriptions.

Retail pharmacy chains, such as Walgreens and CVS, are facing declining consumer favor, resulting in decreased profits and stock prices. This trend is indicative of larger problems within the industry, which have led to store closures and a shift in strategy.

Prescription drug reimbursement rates are among the biggest challenges for drugstores, along with inflation, decreased consumer spending, theft, and competition from Amazon and grocery stores, which are making it difficult for drugstores to profit from the sale of pantry staples, makeup, and cleaning supplies at the front of the store.

Pharmacy staff are experiencing widespread burnout due to understaffing and increasing workloads.

The retail pharmacy model may be broken, as CVS and Walgreens experienced a temporary boost from Covid vaccinations and test sales but now face challenges.

"As the industry begins to recover, retail pharmacies are facing the same challenges they had before Covid, according to Jefferies analyst Brian Tanquilut, who told CNBC that most pharmacies are realizing their businesses have not fundamentally changed."

The declining profit margins of retail pharmacies are exacerbating the problems faced by both Walgreens and CVS.

CVS is facing financial challenges due to rising medical costs in its insurance business, while Walgreens is struggling with its expansion into primary care.

Last year, once a formidable competitor, declared bankruptcy and is now shutting down hundreds of its store locations as it undergoes restructuring.

The stock market has been performing poorly, with Walgreens shares down 59.6% this year and 79.9% over the past decade. CVS' stock has also seen a decline, falling 29.9% both this year and over the past decade. Additionally, Rite Aid's common stock was delisted from the New York Stock Exchange in October.

Retail pharmacy chains are a vital part of the U.S. healthcare system, serving millions of Americans. However, they may need to adapt to remain relevant.

"The retail pharmacy industry is undergoing a period of introspection to determine the most effective approach to connect with consumers, according to GlobalData retail managing director Neil Saunders. With shifting consumer behaviors and evolving economics of operating drugstores and pharmacies, retailers in the sector are reassessing their business strategies to ensure profitability and sustainability."

The pharmacy business is facing several challenges, and CVS and Walgreens are taking steps to adapt.

Falling pharmacy reimbursement rates

The low reimbursement rates for prescription drugs are a major source of pain for retail pharmacies.

Pharmacy benefit managers (PBMs) negotiate discounts with manufacturers on behalf of insurers and create lists of medications covered by health plans, while pharmacies purchase their medications from a distributor and receive reimbursement.

Almost 80% of all prescriptions in the U.S. are handled by the three largest Pharmacy Benefit Managers (PBMs), which are CVS Health's Caremark, 's Optum Rx, and 's Express Scripts.

PBMs have been accused by pharmacies of setting lower reimbursement rates, which can result in pharmacies receiving less payment than the cost of purchasing and dispensing a prescription. Additionally, PBMs have been accused of imposing "take it or leave it" contracts on pharmacies during reimbursement negotiations, forcing them to accept lower rates in order to maintain access to patients covered by PBMs.

"Tanquilut stated to CNBC that retail pharmacies lack leverage and negotiating power, resulting in consistent pressure on their margins, making it a significant challenge for them."

In 2019, Walgreens' U.S. retail pharmacy unit had an operating margin of 3.9%, while CVS' pharmacy and consumer wellness business had an operating margin of 8.5%. However, in 2022, Walgreens' operating margin was -5%, while CVS' operating margin was 4.6%.

Tanquilut stated that CVS has a slight edge over Walgreens because it owns its own PBM, and the margin pressure from Caremark is likely less severe for other PBMs.

In December, CVS introduced a new pharmacy reimbursement model called CostVantage, which will launch at the beginning of next year and use a transparent formula to determine medication prices. This will provide more clarity and predictability for consumers, according to a CVS spokesperson.

Some analysts informed CNBC that the effectiveness of the new model remains uncertain.

According to Saunders, the use of online pharmacy services like PillPack, which is owned by Amazon Pharmacy, is increasing among consumers who get their prescription medications. Although he stated that online pharmacy fulfillment is still small compared to traditional pharmacy chains, he noted that it is growing and putting some pressure on them.

Front-of-store woes

The pharmacy businesses of Walgreens and CVS face an even greater threat from e-commerce rivals, discounters, and big-box retailers.

Analyst Michael Cherny of Leerink Partners states that the online retail presence of the chains has fallen behind that of Amazon and other retailers such as Walmart and Target as competition intensifies.

"Cherny stated that it was unlikely for someone pre-Covid or during the early days of Covid to prioritize shopping at CVS.com or Walgreens.com due to their lag in e-commerce development."

Despite the convenience of retail pharmacies, budget-conscious shoppers are more likely to shop at retailers such as Walmart, dollar stores, or Costco, according to Cherny.

According to Brittainy Lynn, a 38-year-old freelancer from Austin, Texas, "it seems like prices are really high" at Walgreens and CVS compared to other stores.

"Lynn told CNBC that she doesn't usually choose to shop at Amazon, but it's where she often finds the cheapest prices. While she also shops at Walmart, she doesn't rely on it for essentials."

Consumers' watchful spending has contributed to weaker retail sales at Walgreens and CVS.

During the second quarter, CVS reported a 4% decline in same-store sales at the front of the store compared to the same period last year, indicating a "general weakening of consumer demand."

In the fiscal third quarter, Walgreens reported a 2.3% decrease in same-store retail sales compared to the previous year. The company attributed this decline to "significant challenges" in a "worse-than-expected consumer environment" within its U.S. retail pharmacy business.

Both Walgreens and CVS have intensified their emphasis on private-label products in an attempt to attract customers who have shifted away from national brands in an effort to combat inflation.

A Walgreens spokesperson stated that the company is experiencing "great success with its own brand products," as brand penetration continues to increase. The company is also expanding its product offerings, introducing 37 new items in the second quarter. This, the spokesperson said, aligns with consumer demand for value.

Walgreens more exposed to retail pharmacy pressure

Elizabeth Anderson, an Evercore ISI analyst, stated that while major chains face similar challenges, Walgreens is more vulnerable to the pressures affecting its retail pharmacy business compared to CVS.

Aetna, the nation's third-largest health insurer, could help offset issues on the retail pharmacy side for CVS, which also operates a PBM.

Last year, CVS' retail pharmacy unit generated $116.76 billion in sales, while its health services segment, which includes Caremark and Oak Street Health, recorded nearly $187 billion in sales.

The majority of Walgreens' revenue comes from its U.S. retail pharmacies, with the business unit generating over $109 billion last year, compared to $21.83 billion from its international segment and $1.8 billion from its health-care unit.

Boots is a U.K.-based health and beauty retailer that is owned by Walgreens, which operates more than 3,000 retail stores abroad. Walgreens' health-care unit provides primary care, urgent care, post-acute care services, and a specialty pharmacy, among other offerings.

Despite Walgreens' efforts to expand its business, it has been lagging behind CVS in the healthcare industry, as noted by Jeffries' Tanquilut.

Pharmacies and retail giants are striving to provide medical care directly to patients, which could increase their market share in the over $4 trillion U.S. health-care industry.

Several major companies, including Amazon, Walmart, CVS, and Walgreens, are experiencing financial strain due to their investments in primary care clinics, according to Tanquilut. The reason for this is that establishing clinics requires a significant amount of capital, and they often do not turn a profit for several years.

Unlike CVS, Walgreens may exit the primary-care market entirely, as the company announced in a securities filing last week that it is considering selling its VillageMD subsidiary.

In 2020, Walgreens invested $1 billion in VillageMD, and in 2021, it invested another $5.2 billion to become its majority owner. However, last year, Walgreens began closing clinic locations, resulting in a nearly $6 billion charge in March related to the decline in value of its investment in VillageMD.

What's the future of the retail pharmacy?

Evercore's Anderson predicts that retail pharmacies are unlikely to vanish soon due to the aging American population and the increasing need for prescription pick-ups.

She suggested that they might not have to maintain their current form, which could imply expanding their online presence, discontinuing certain products such as greeting cards, and reducing their physical storefronts.

Anderson stated to CNBC that he believes there will be experimentation with models in the retail pharmacy industry. The focus, however, is on what the new retail pharmacy model will entail.

This year, Walgreens plans to increase the number of its "mini drugstores" to about 100, with a focus on branded products and fewer front-of-store items and over-the-counter medicines.

Walgreens is testing a Chicago store that emphasizes digital pickup, pharmacy, and grab-and-go options, with most orders able to be placed and filled at a counter, potentially discouraging theft.

In Aubrey, Texas, the pharmacy is now located at the front of the store, deviating from the conventional arrangement.

The company will not launch new pilot stores until it has a better understanding of what works and what doesn't.

A CVS spokesperson stated that the company is innovating to meet the diverse needs of its customers and patients. The spokesperson highlighted CVS's private-label brands, range of national brands, and loyalty program that provides discounts and benefits for patients.

CVS Health and Oak Street Health have opened primary-care centers next to CVS pharmacies in Texas and Illinois, with plans to launch approximately two dozen more by the end of the year.

Shuttering stores to shore up profits

In the meantime, CVS and Walgreens are cutting costs.

In June, Walgreens announced plans to close a "significant" number of its 8,600 U.S. stores. The CEO, Tim Wentworth, stated that only 75% of the chain's locations were profitable and that a significant portion of the other quarter could shutter by 2027.

A Walgreens spokesperson stated that the company has the ability to make difficult decisions that benefit its business, as it identifies opportunities that unlock value, validate existing pathways, and lead to a successful future.

Nearly 10% of CVS's U.S. retail locations will be shuttered over a three-year period, with 851 stores closed to date.

A CVS spokesperson stated that store closure decisions are based on factors such as population shifts, consumer spending patterns, and store density, among others. Despite the closures, 85% of people in the U.S. will still have access to a CVS pharmacy within 10 miles.

According to Amar Singh, senior director at retail consulting company Kantar Group, closing underperforming locations could aid Walgreens and CVS in determining "the right equation" for their stores, which would help them regain the trust of customers and increase their profits.

Pharmacy closures in underserved communities across the U.S. could make it harder for many Americans to obtain prescriptions.

According to Saunders, addressing declining reimbursement rates in retail pharmacies may require legislation and lobbying, and "getting that done is almost impossible."

""While closing stores may be a response to the issue, it is not the solution. If other factors remain unchanged, they may face the same predicament in 10 years and need to close more stores," Saunders stated."