The headlines, spurred by Amazon’s entry into the pharmacy business, were as entertaining as they were exuberant. One hailed the company’s 1999 investment in Drugstore.com as “a likely gold mine.” In Canada, the Globe and Mail predicted a sea change in shopping habits, titling its story: “Farewell, Preparation H aisle.”
Nearly 20 years later, shoppers are still awkwardly perusing that aisle and getting their prescription drugs from many of the same bricks-and-mortar pharmacies. Drugstore.com no longer exists and never recorded an annual profit.
It turned out that the pharmacy business, especially in the United States, was harder to disrupt than Amazon (AMZN) and its partners had predicted. Amazon is much bigger now and has built a substantial business selling over-the-counter medicines and other products. But if it launches a second foray into prescription drugs, as it appears to be considering, the online behemoth would face many of the same obstacles that derailed the first effort.
Back then, the company bought a 46 percent stake in Drugstore.com and began marketing its products on amazon.com. But its ambitions to sell prescription drugs slammed into a thicket of regulations, logistical challenges, and pre-existing business alliances that effectively blocked it from huge segments of the market. Today, it would still have to establish business and medical expertise to safely sell and distribute drugs. And it would have to figure out how to unseat, or outmaneuver, existing pharmacy benefit managers (PBMs) whose dominance of the market has only become more absolute since the late 1990s.
“That’s the problem — you’ve got these incumbents who have a huge amount of control through the contracts they write,” Dawn Lepore, the former CEO of Drugstore.com, said in an interview with STAT. “This is an area that needs to be innovated dramatically, but the PBMs have a lot of power.”
She isn’t counting Amazon out. Lepore, who now advises companies and serves on corporate boards, said Amazon has the scale and reach to pose a serious threat, despite the challenging economics of the pharmacy sector. “Prescriptions are relatively low margin, but Amazon runs a low margin business, so the company knows how to make money in low margin,” Lepore said. “It’s also already got the customer base, so it may be that Amazon can make economics work where other businesses can’t.”
Still, she said, selling prescription drugs is different from selling shampoo or toys or fresh produce. The opportunities to disrupt it are more discreet and require deft maneuvering — lessons Amazon founder Jeff Bezos had the chance to learn, perhaps somewhat painfully, during his years on the Drugstore.com board.
PBMs control the market
Lepore said a major problem with Drugstore.com’s prescription drug business took root before she was hired to lead it in 2004. Medco Health Solutions, then one of the nation’s largest pharmacy benefit managers, had shut it out of its network of tens of millions of U.S. customers.
“For 1 out of 5 people who came to the site, we would have to tell them we didn’t take their insurance,” Lepore said. “That was one of the reasons our [prescription drug] business wasn’t that big.”
Amazon would also have to find a way to access customers now served by a small number of PBMs. In 2012, Medco was purchased by Express Scripts, one of three companies — along with CVS (CVS) Health and OptumRx — that control pharmacy benefits for about 80 percent of the U.S. population.
To reach those customers, Amazon would either have to strike up partnerships with one or more of the PBMs or build its own PBM and become a network pharmacy itself. Even if it did so, it’s not a foregone conclusion that Amazon could effectively compete, said Adam Fein, chief executive of the Drug Channels Institute, which analyzes the industry’s trends and underlying economics.
“It’s a big market, but it’s not an especially inefficient market,” Fein said. “In the United States, we process and pay for almost 6 billion 30-day-equivalent prescriptions a year for a population of 326 million people. We’ve built a very complicated infrastructure to do so, and that infrastructure cannot be easily dismissed.”
In addition, the mail-order portion of the market is shrinking, as retail pharmacies have been cutting their prices to drive customers into their stores, where they can sell them everything from groceries to hardware.
Amazon now has a larger bricks-and-mortar presence due to its acquisition of Whole Foods, but it is not set up to sell prescription drugs through those stores. And even if it established that ability, it would just be another entrant in an already crowded field, which raises a crucial question: What is Amazon’s best opportunity to differentiate itself?
Exploiting the weak spot
Facing sluggish growth and better opportunities on over-the-counter products, Drugstore.com sold its mail-order pharmacy unit for $5 million in 2010. But there was one portion of the prescription drug market where it could still compete: cash-paying customers.
Lepore said the company continued to sell Propecia (for hair loss) and Viagra (for erectile dysfunction), among other products. Those drugs were not typically covered by insurance, making it easier for Drugstore.com to attract customers with convenience and reasonable prices.
The cash-pay market presents a significant opportunity for Amazon because of the sky-high prices retail pharmacies often charge to customers who don’t have insurance or face high out-of-pocket costs.
Fein described the dynamics in a recent blog post: Pharmacies set their cash prices artificially high to maximize their reimbursement from insurers, who won’t pay any more than the listed cash price. If pharmacies set that price too low, then they risk leaving money on the table.
Consequently, customers paying out of pocket often encounter inflated prices for generic medicines that Amazon could undercut. The cash-pay segment accounts for 8 percent of the total U.S. market, or about 400 million 30-day-equivalent prescriptions.
Still, Fein said, Amazon would have to become a full-service pharmacy so customers could get all their prescriptions from the same company, rather than shopping different pharmacies that don’t know their regimens and can’t monitor them for adverse interactions. That would require the e-commerce giant to make significant investments for an uncertain payoff.
“Amazon could try to compete on price, but the profitability and margins on generic drugs at pharmacies are not large,” Fein said. “It’s not really clear what advantage they have.”
A master of logistics
Since the late 1990s, when Amazon took over bookselling and began expanding to other markets, it has mastered the challenge of getting a vast array of products to customers quickly.
In his recent annual letter to shareholders, Bezos reported that the company shipped more than 5 billion items to its Prime subscribers in 2017. It now offers one-day or same-day shipping to 8,000 communities and, through Whole Foods, it can deliver groceries to customers in some cities within two hours, a service it is planning to expand nationwide.
But selling and distributing prescription drugs comes with unique challenges. Pills cannot be stored on warehouse shelves next to diapers and boxes of macaroni and cheese. Many prescriptions require cold storage and come with specific handling instructions to preserve the quality of the medicine and prevent theft of controlled substances. What’s more, Amazon would need to hire licensed pharmacists to fill prescriptions and ensure that the right drugs, in the right dose and quantity, go to the intended customers.
These are processes that existing PBMs and other participants in the supply chain have been honing for decades.
“For companies (like an Amazon) that may be considering moving into the PBM space, they have to be more than strong logistics companies,” said Henry Eickelberg, a managing director at the Terry Group, which consults on pharmacy and medical benefits. “It takes a lot of different skills beyond efficiently moving products.”
It is clear, however, that these complexities are not lost on Amazon. In addition to its experience with Drugstore.com, the company has spent years amassing expertise in the pharmacy field and appears to be following a methodical process to examine its opportunities and options.
“If you look at the people they’ve hired and are looking to engage with, there is no question they’re focused on the distribution of pharmaceuticals and medical devices,” said Patrick Finnegan, an analyst with Fitch Ratings. “They’re getting educated. They know they can’t just jump into this and write a check.”
Finnegan, who covers wholesale distributors and pharma companies, said Amazon is trying to zero in on unnecessary costs and complications in the supply chain. In some corners of the business, those problems are not hard to find. But fixing them in a way that serves the customers and generates profit is another matter.
“They really need to build a better value proposition before they can come in to disrupt very established players,” Finnegan said. “These are very capable companies.”