Rx for E-drugstores

A trip to the drugstore, by car or on foot, is a habit deeply entrenched among consumers, who have yet to turn to online ordering of medications, health and beauty products to the same degree they’re now willing to buy books, CDs, computers and even clothing online. In fact, according to 2004 data from Forrester Research, of U.S. consumers surveyed who take prescription drugs, only about 9% have filled a prescription online.

The demise of most of the purely web-based drugstores; the continuing struggles toward profitability of Drugstore.com, the largest remaining pure-play in the category; and the fact that online sales represent only a tiny share of total sales for drugstore chain giants such as Walgreen Co. and CVS Corp. are all testament to that. And overall, online sales of prescription drugs, estimated at $5.6 billion by Jupiter Research in 2004, remain a very small drop in a big bucket, given that U.S. spending on prescription drugs was $188 billion that year.

More than habit

But consumers’ slow uptake hasn’t blotted out the promise of the online channel among industry players—it’s simply shifted earlier strategic thinking and caused them to reach for that promise in new ways.

While the industry has long believed that online prescription ordering is perfectly logical, consumers have been slow to fulfill that belief. Beyond habit, a closer look at what drives the largest share of revenue at drugstores—and who’s buying much of that—may offer a clue as to why category sales online have been slower to catch on. Prescription drugs represent the largest share of chains’ sales: 64% at Walgreen’s in fiscal 2005; about 70% at CVS in 2004. Older consumers are the buyers of a sizeable chunk of the prescription drugs sold across all channels—a demographic currently less likely to buy anything online.

In addition, the evolution of how drugs are paid for is having a big impact on the online industry. Health benefits providers are the largest payers for prescription drugs, and retail prices for covered drugs go through a long chain before the drugs end up in the consumer’s hands. Figuring in the price chain are negotiations among drug manufacturers, benefits providers and the pharmacy benefits managers to which they subcontract drug benefits administration, then wholesalers and finally, the drugstores. By the time the drugs get to the retail level, drugstores have little pricing flexibility. The result is that the sale of covered prescription drugs at retail is a high-volume, low-margin business which means that while prescription drug sales may represent most of a drugstore’s sales, they don’t represent most of the profits.

Store pick-up

How multi-channel drugstore chains and pure plays are addressing that fact is helping to cast the Internet in different roles at different companies. Drugstore chains that added an Internet channel at the height of the dot-com boom as a hedge against pure-play online drugstores now see a different utility for their web sites.

The earlier fear that the online channel would overtake brick-and-mortar stores was what kick-started web efforts at chains such as Walgreen’s and CVS, according to Vikram Sehgal, Jupiter Research analyst. “But they soon realized that online sales weren’t going to eliminate offline sales and that consumers don’t necessarily prefer the online channel,” he says. “So now they’ve moved to the store pick-up model. The idea here is dual: first, they’re continuing with the online channel even though it is not contributing large sales, and secondly, it’s another tool to bring people into the store.”

It’s a different story at pure-play Drugstore.com. It got only about one-quarter of its $399 million in sales last year through store pick-up of online orders—it has a relationship with chain Rite-Aid for store pick-up as one fulfillment option for prescriptions. Drugstore.com, unlike its offline brethren, doesn’t look for its major revenue from insurance-sponsored prescriptions, though it has relationship with a number of pharmacy benefits managers and health plans for covered drugs. Instead, Drugstore looks to drive online prescription sales with a focus on the customer who pays for a prescription out of his own pocket either because insurance doesn’t cover the cost or doesn’t cover enough of it.

So-called “lifestyle” prescription drugs—for instance, the hair treatment Propecia—constitute a large share of the self-pay category. Drugstore attracts self-payers with prices on some drugs that may be as much as 25% below the going rate at other pharmacies, says Jonathan Tinter, Drugstore’s chief marketing officer. Negotiating directly with manufacturers and wholesaler suppliers, Drugstore has more flexibility in pricing the drugs not typically covered by insurance, and it passes some of those savings on to self-payers as a key element of its value proposition, according to Tinter.

Front-of-store boost

But even more than with lower prices for self-payers on prescription drugs, Drugstore.com looks to higher-margin, front-of-store products to boost revenues: at $174 million, they represented 44% of total sales and more than 60% of margin contribution last year, while so-called mail orders—mailed fulfillment of prescription drugs ordered online—accounted for only $76 million or about 19%.

“They’ve expanded their business substantially since their inception to include higher-end beauty lines and items with a greater margin that are harder to find,” says Liz Boehm, Forrester Research analyst. Tinter estimates that across its online store and the linked site Beauty.com, which it owns, Drugstore.com offers about 25,000 health and beauty products against the typical drugstore’s 5,000. This includes brands and lines not typically found in chain drugstores, such as Philosophy skin care products, for example.

Drugstore’s shopping cart allows customers to shop both the prestige brands at Beauty.com and the mass-market offerings at Drugstore using a single cart. That convenience, the broad assortment and lower prices on the kind of prescription drugs whose cost is more typically borne out of pocket are what’s driving more traffic to Drustore.com rather than to the web sites of Walgreen’s or CVS. For example, in January, Drugstore.com had 3.65 million visitors to Walgreen.com’s 3.53 million, according to comScore Networks. CVS.com posted the fourth-highest traffic in the category that month at 1.96 million unique visitors.

Given Walgreen’s 5,000 stores in the U.S. and Puerto Rico, its economies of scale and its prescription pharmacy business targeting insured prescription drugs, it’s obvious Walgreen’s needn’t work to position itself against Drugstore as Drugstore must work to carve out a niche against Walgreen’s. Yet soaring traffic at Walgreen’s.com, up 62% January over January, vs. a 40% gain at Drugstore and 27% at CVS.com, shows the chain is nevertheless out to grow its web traffic. To do that, it goes above and beyond a product offering comparable to the other chains with consumer health content from the Mayo Clinic, detailed health information FAQs and pharmacists on call who will answer confidential e-mail health queries from customers via e-mail. It’s also beefed up site navigation, search and merchandising.

The photo op

IRCE 2008 Conference Multi-Media CD-ROM

CVS.com, too, has buffed up its web offering with several personalization features, allowing customers to order prescriptions for mail order or pick up in a store, schedule refill reminders, check out a prescription price list and read health-related questions and answers on topics written by pharmacists. As at Walgreens.com, visitors can click on CVS.com and see digital versions of the chain’s weekly fliers that enable them to buy the same products online or in a store.

And if one of the web’s jobs for multi-channel retailers is to pull people who order online into the store for pick-up, Walgreen’s is fulfilling that mandate with a new online photo service that gives web users another reason to come to its stores. A relationship with HP Snapfish lets customers upload photos to Snapfish.com for printing and then pick up at a Walgreen’s store an hour later. “Our partnership with Snapfish gives customers a very convenient online photo service at a competitive price,” says John Sugrue, divisional merchandise manager for one-hour photo. The photo service has helped make consumers remember Walgreen’s as place to pick up shampoo, a gallon of milk, or a pack of gum, when their prints are ready, analysts note.

“The online photo service has significantly exceeded Walgreen’s expectations,” says Mark Miller, a retail analyst for investment firm William Blair & Co. Miller notes that a major percentage of customers who upload photos online for processing are in the store to pick them up within two hours. “It’s all about convenience,” he says. Under the same strategy, CVS.com offers a digital photo processing service that lets shoppers pick up their prints in a CVS store.

At less than 1% of Walgreen’s total sales, there’s plenty of upside for Walgreen’s on the web, and CVS is similarly positioned. Though they face little real competition on the benefits-sponsored prescription drug side from Drugstore, which is pursuing a different segment of the prescription market as well as online over-the-counter sales, they do face competition in growing their online prescription fulfillment business from another quarter: pharmacy benefits management companies. These are companies that administer the pharmacy portion of a health insurance plan under contract with the employer or other health benefits sponsor. Pharmacy is a complex and specialized area of health insurance, and PBMs are generally charged by the benefits sponsor with keeping costs in line.

The PBM push

“The majority of prescriptions being sold online are being sold through PBMs,” says Boehm. In fact, at 1.96 million unique visitors in January, pharmacy benefits management company Medco Health had as much traffic as CVS.com. And at 936,000 unique visitors, another PBM, Express-Scripts.com, ranked six in the online pharmacy category that month.

According to Sehgal, much of the growth in the online sale of prescription drugs is coming specifically from PBMs that are actively pushing their mail order business to the online channel, and it’s a natural evolution. “There is a segment of consumers who are okay with the idea of fulfilling prescriptions remotely, whether they do that over the phone or through mail order. This group is moving toward online purchasing,” he says. Sweetening the deal for consumers getting chronic-care medications from PBMs is that PBMs can generally provide a 90-day supply on one co-pay, versus a 30-day supply per co-pay available at a drugstore.

Drugstore chains are well aware of online competition from PBMs, and they’re responding in a variety of ways; for one, meeting them on their own turf. Walgreen’s, for instance, owns its own PBM, as does CVS, and it can provide that capacity in-house to employers and health benefits sponsors. Drugstore has fulfillment relationships with some PBMs. And all are leveraging the combination of online ordering with a brick-and-mortar presence for consumers seeking acute-care medication on a short turn-around. “Walgreen’s and CVS realize what competition from PBMs is taking away, but a lot of their business is from acute drugs, which consumers don’t want to wait for by mail,” says Sehgal.

Ultimately, different segments of the online opportunity will have greater or lesser importance to chains, PBMs and pure-plays depending on their individual strategies, but given the total size of the prescription drug and health and beauty markets, any challenges drugstores face in growing online business won’t be enough to hinder eventual expansion in their chosen direction. According to Sehgal, there’s space for both online and multi-channel models. “If you look at other categories, there is room for an online-only player compared to a brick-and-mortar or a brick-and-clicks player,” he says. “It all depends on how they position themselves.” l

mary@verticalwebmedia.com

Don’t believe everything you see in your inbox

If the amount of e-mail solicitations that crowd inboxes actually reflected the percentage of consumers’ prescription dollars that were spent at so-called online rogue pharmacies, one might conclude they’ve grabbed the lion’s share of the lifestyle and self-pay prescription drug market. But in fact, it’s a minuscule amount.

Rogue pharmacies—those Internet-only drugstores that seem to pop up out of nowhere—came to attention a few years ago, prior to the recent Medicare Modernization Act which seeks to expand access to drug benefits under Medicare. Pop-up Internet pharmacies from outside the U.S. offered the promise, at least, of pricey prescription drugs at less cost for those who were paying out of pocket. “People were re-importing these medications on web sites from who knows where. It wasn’t safe, so part of the solution was that we needed an affordable drug benefit for individuals who didn’t have drug coverage, and most of them were on Medicare,” says Forrester Research analyst Liz Boehm. The online pharmacies have expanded their offering to include lifestyle prescription drugs.

Boehm says re-importation still goes on, and while technically the legality of the practice is questionable, some pharmacies in this group are legitimate pharmacies in their home countries. “The challenge is that it’s tough to differentiate a legitimate pharmacy from someone selling sugar pills and calling it Propecia,” she says.

Boehm adds that the new Medicare drug benefit isn’t going to make overseas pharmacies and outright rogue pharmacies disappear from the Internet, particularly since the benefits as outlined in the act are proving extremely difficult for consumers to understand. Nevertheless—spam aside—these represent a very small percentage of the prescription drug market. According to Boehm, in 2003, for example, of the 12% of U.S. consumers surveyed who had purchased drugs online, only 9% said they’d purchased from an overseas pharmacy, and only 6% said they’d purchased a drug without a prescription. “The numbers were tiny,” she says.