With top management steeped in marketing and merchandising experience, Drugstore.com is ready to push hard to become a (profitable) household word
By Paul Demery
When Drugstore.com Inc. launched in 1999, it made a splash like other early dot-coms through an aggressive advertising campaign. But while many other early e-retailers overspent on hype until they went out of business, dying before they had secured an effective infrastructure and loyal customers, Drugstore sharply cut back on marketing to focus on building a loyal base of customers who would return to a retail web site that worked.
In many ways, Drugstore has met the goals of its second strategy. Its 2004 net sales grew 47% year-over-year to $360.1 million, and, with an active customer base of 1.9 million, it generated 74% of last year's revenue from repeat customers. And though it hasn't bombarded consumers with advertising messages, Drugstore has won accolades for its customer service and technology.
JupiterResearch, for example, cited the pure-play retailer in a report last fall for having the most effective site search feature. While some leading online retailers disappoint many customers with site search that lacks product information or proactive messaging, the Jupiter report, "Retail Site Search, Site Ranking and Best Practices," cites Drugstore for such features as highlighting specials and best-sellers on the first page of search results and supporting further navigation through several categories of related information. "When consumers try us, they like us," says Dawn G. Lepore, the company's new CEO and chairman of the board.
Looking for something big
But Lepore, a former Charles Schwab Corp. vice chairman who was brought in last fall with a strong reputation for building and marketing e-commerce operations, faces big hurdles in overcoming Drugstore's ongoing financial losses. Despite the rise in 2004 sales, Bellevue, Wash.-based Drugstore posted a net loss for the year of $47.7 million, widening by about 150% its year-earlier loss of $18.6 million.
To straighten out its financial situation and head toward profits, analysts say, Drugstore must implement major improvements sooner rather than later. "They have enough cash to continue operating for a few years, but their guidance for 2005 is not that great and they haven't answered what they need to do to be profitable and to scale their business," says Peter Spear, an analyst with investment research firm Delafield Hambrecht Inc. in Seattle, which does not have a financial stake in Drugstore. He says Drugstore is on the right track in its pursuit of multiple marketing partnerships and the trend toward mail-order prescription sales required by health insurance plans. Beyond that--and outside of dressing up Drugstore for an acquisition by a larger retail organization--Lepore and her team need to find new ways to streamline costs while also building revenues, he adds. "It's a wait-and-see story, but something has to happen with this company, something big," he says.
Drugstore is projecting 2005 net sales to grow about 10-16% to a range of $400 million to $420 million, but as it figures out the right growth formula it also faces formidable competition from large multi-channel drug retailers Walgreen Co., CVS Corp. and Wal-Mart Stores Inc. Even Amazon.com Inc., which holds a 16% equity stake in Drugstore, has entered a big part of its market with two beta sections of its mass merchandise web site: one covering non-prescription drugstore items like painkillers, toothpaste and razors, the other offering beauty products like designer-brand perfumes that compete for the high-margin market Drugstore is pursuing through its own Beauty.com.
Small and nimble
But if all that sounds like a lot on the shoulders of Drugstore's new CEO, it doesn't seem to dampen her confidence for bringing the 6-year-old, 625-employee e-retailer to a new level of performance. "I came to Drugstore partly because I missed being with a company that's small and nimble, where it's easier to get things done," Lepore says.
Lepore, who succeeded Kal
Raman, a key designer of Drugstore's e-commerce platform, is no newcomer to taking on challenges that mix business and Internet technology. She served as Schwab's vice chair in charge of technology, operations and administration and, as its one-time CIO, played a key role in building out the investment firm's e-commerce strategy. Lepore has also served as a member of the board of Wal-Mart, a position she left when joining Drugstore to avoid a conflict of interest, and continues to serve on the board of eBay Inc. "Even though she's from financial services retailing, she's a successful, seasoned executive and brings a lot to the table in online retailing," Spear says.
Lepore wasted no time in making her mark on Drugstore after she arrived in October. Her multi-pronged strategy targets growth in Drugstore's four core areas of general over-the-counter merchandise, mail-order prescription goods, local in-store pickup of online orders through Rite Aid stores, and online sales of contact lenses through VisionDirect.com, which Drugstore acquired in late 2003.
Taking all that on, she admits, will require additional investment in both marketing and technology, risking a delay on the road to profits. But Lepore is betting that leveraging those investments will lead to the scale of customer activity necessary to produce profits, as Drugstore raises its image in the minds of consumers, improves its e-commerce technology platform to provide customers an easier shopping experience and creates more revenue-boosting cross-selling opportunities.
Driving up OTC traffic
Figuring the most important key to growth is getting consumers to move more of their non-prescription purchases from stores to the web, Lepore quickly filled a void in over-the-counter product marketing and merchandising by naming Kathy Gersch, a veteran e-retailing executive of GiftCertificates.com and Nordstrom.com, to the new position of vice president, chief marketing officer and general manager of the retailer's non-prescription business. For the first time in several years, Drugstore will have a single executive in charge of both marketing and merchandising for its over-the-counter business--making it easier to present a coordinated merchandising and marketing strategy to consumers, Lepore says.
"We need to spend more time on marketing and branding," she says. "We hear from customers that they love us but don't know the breadth of products we carry. Others say they don't come back, not because they're unhappy, but that they just didn't think of us."
She knows what Drugstore needs to do about that. "Our message has to be consistent," she adds. "The way the web is designed, brand ads, e-mail ads, all need to be consistent with a branding strategy, with who we are and what our value proposition is."
Gersch lays out in hard numbers one of the immediate goals Drugstore needs to reach. "Our average customer shops with us 1.4 times per year, then the other 25 times in a brick-and-mortar drugstore," she says. "I don't expect to get to half and half, but if I can get them to shop with us one more time a year, we'll double our sales."
Offline advertising
Much of Lepore's and Gersch's success in pushing Drugstore's growth this year will hinge on an advertising campaign that will debut later this year. Drugstore has retained Acme Idea, New York-based marketing agency, to work on a campaign that will go beyond Drugstore's current marketing emphasis on online campaigns. Although they've yet to decide on the ingredients of a new campaign, it will likely encompass multi-media offline advertising, including TV spots, that emphasize the Drugstore.com brand and inform consumers that the web site can make life easier when ordering everyday staples like tissues and soap as well as recurring medicines, Gersch says.
A more aggressive advertising campaign, especially one designed to promote a brand rather than individual product promotions, Lepore admits, can add to operating expenses before bringing in a noticeable increase in customers. The new campaign is likely add to Drugstore's cost of acquiring news customers, now at a favorable $19 each, down from about $22 in the past, Lepore says.
And though a new advertising campaign will add to expenses Drugstore is already carrying for its 3-day free shipping offer, which put a squeeze on Drugstore's Q4 gross margin of 20.2%, Lepore says she's confident the investments will continue to pay off in sales increases.
Drugstore's new executives say they'll leverage the advantages the web channel brings to the table in scaling up to more customer activity and sales. In addition to spreading the message that the online channel can make life easier for, say, a busy parent with young children who can shop online after getting the kids to bed, Drugstore is planning to promote other advantages that may be less apparent to consumers.
One is the use of flexible spending accounts, which let consumers use untaxed income to purchase health care items not covered by insurance. A forthcoming Drugstore campaign will inform consumers what many apparently don't know--that they can use FSAs to pay for many non-prescription items like Tylenol, Gersch says. In addition, Drugstore provides an online tool that lets shoppers check a list of FSA-approved products and monitor the balance in their account. It's also working on a feature that will let shoppers purchase items with funds directly drawn from their FSAs.
The retailer is also looking into developing more personalized and easier-to-read e-mail marketing campaigns. "We'll have customers tell us what communication they want from us," Lepore says. "For example, if they like a product that a manufacturer plans to discontinue, we'll tell customers to let them stock up on it."
In addition, Drugstore is testing several new site features to make online shopping easier and encourage customers to return more often, Lepore says. One thing under consideration is a simpler version of the site for new customers. "Our web site can be a little overwhelming for the first-time user, so an easier shopping experience could be very effective," she says.
Among its several marketing efforts, partnerships stand out as the most efficient and effective tool for acquiring new customers, Gersch says.
Drugstore spends 6% of its marketing budget on partnerships to realize 49% of orders, compared to spending 53% on search engine marketing to generate 30% of orders, she says. "95% of customers that come to us through partners are new to us," Gersch says.
The Rite-Aid connection
One of its most established partnerships is with Rite Aid Corp., which allows orders placed over Drugstore.com to be picked up at any of more than 3,400 Rite Aid stores. Drugstore's net sales processed through Rite Aid stores rose 8.6% last year to $92.4 million, up from $85.1 million in 2003. Although that may be strong growth by most retail measures, it was the only one of Drugstore's operating units with a single-digit growth rate.
By comparison, online prescription drug sales grew 30% to $63.9 million from $49.2 million; over-the-counter sales surged 42.3% to $155.3 million from $109.2 million; and the VisionDirect unit grew 20-fold to $48.5 million from $2.3 million.
Lepore says she plans to meet with her counterpart at Rite Aid to discuss how the two companies can better cooperate and describes store pick-up as an element of customer choice that can help Drugstore compete with multi-channel rivals.
But her main emphasis for growth, she says, is on developing online shopping to lure more consumers to pass up stores for the web.
Other partnerships that support this strategy include an exclusive arrangement to handle online sales for GNC, the vitamin and natural foods retailer, and groups that cater to specific communities of health care recipients. Drugstore is working on a multi-channel marketing campaign, for example, with dLife, an organization that educates diabetes patients on proper health care through several channels, including dLife.com and the dLife cable TV show, which will debut this month on CNBC.
Prescription edge
Drugstore is also working to shore up its prescription sales by taking advantage of a move by health care benefit plans to require policy holders to order recurring drugs through the mail and in larger quantities than is typically ordered through neighborhood pharmacies. Jefffrey J. Kimmell, vice president of health care services and chief pharmacy officer, says he spends a good part of his time meeting with benefit plan administrators to arrange for Drugstore to operate as their distribution vehicle.
One of Drugstore's fortes in its prescription drug market is a remnant from its early days--the 45,000-square-foot automated pharmaceutical lab, where a staff of 19 certified pharmacists working alongside automated medicine-dispensing machines can crank out up to 15,000 prescriptions a day. Although it may lack the personal touch of a neighborhood pharmacist, says Kimmell, a registered pharmacist who grew up helping out in his father's pharmacy, the automated system frees up Drugstore's pharmacists from the mundane chores of filling up pill bottles or directing customers to the toothpaste aisle. "What also distinguishes us from a brick-and-mortar pharmacy is that each prescription order is checked by a minimum of three pharmacists," Kimmell says.
While analysts say there's little room for pharmacies to compete on the set pricing for prescribed drugs covered under insurance plans, Kimmell notes that Drugstore is often 20% or more cheaper for prescribed drugs, such as Viagra, when they're not covered by health insurance.
Drugstore also leverages the web channel by e-mailing reminders to customers when it's time to renew prescriptions, and alerts regarding medicines that may be recalled by the Food and Drug Administration or manufacturers, Kimmell says.
Reaching profits
Drugstore also counts its 290,000-square-foot warehouse in Swedesboro, N.J., as a plus in competing with chains because it does not operate an expensive brick-and-mortar network. "We have one distribution center instead of hundreds, and we have 20,000 SKUs and could easily increase that," Lepore says.
The warehouse could handle a doubling of annual sales, to over $700 million from last year's $360 million, before Drugstore would have to expand its capacity, she adds.
That could play a crucial role in Drugstore's ability to scale up without drowning in additional costs. Its potential to turn things around is being picked up by analysts. Spear notes that, despite its 2004 net loss, the retailer's EBITDA loss actually showed an improvement for 2004 over 2003. He projects that Drugstore will show an EBITDA profit by the fourth quarter of this year and for the full year 2006. (EBITDA is earnings before interest, taxes, depreciation and amortization.)
Drugstore's gross profit margin should grow from just over 20% to about 21.5% next year, as the retailer reaches positive net income by the fourth quarter of 2006, Spear says. But he cautions that Drugstore will have to find a way to tighten costs as well as grow revenue. "If they can't get to positive earnings by Q4 2006, then they should consider another business model," he says.
Although she hasn't made similar projections, Lepore's enthusiasm for Drugstore indicates such performance is within her expectations. "There's a great opportunity here, and I'm excited about it," she says.
paul@verticalwebmedia.com
