9 - 717 - 436

R E V : F E B R U A R Y 2 8 , 2 0 17

M I C H A E L E . P O R T E R

J O R G E R A M I R E Z - V A L L E J O A L E X A N D R A H O U G H T A L I N

CVS Health: Redefining the Value Proposition

Put simply, the sale of tobacco products is inconsistent with our purpose.

— Larry Merlo, President and CEO of CVS Health

Introduction

Founded in 1963, CVS Health (CVS) was the leading drugstore chain in the United States. Headquartered in Rhode Island, the company had grown to more than 9,600 retail drugstores and 243,000 employees operating in all 50 states in 2015.

Since 2006, the company had been expanding its role in health care, moving beyond the traditional drugstore. In 2014, reflecting this new approach, the company changed its name to CVS Health and stopped selling tobacco products in its stores.

In 2015, the U.S. health care system continued to evolve. Health systems were expanding and consolidating, new health care delivery models were emerging, and reimbursement was changing. Some physician lobbying groups were resisting the expansion of care in non-traditional settings. CVS had to navigate a rapidly shifting competitive environment.

Health Care in the United States

Health care costs in the U.S. had been rising rapidly since the 1970s, reaching more than $3 trillion per year by 2015, or about 18% of GDP.1 The United States spent more per capita on health care than any nation in the world, reaching 2.5 times the OECD average. Average life expectancy in the U.S. was slightly below the OECD average at 79 years and the U.S. faced a greater burden of chronic disease, disability, injuries, HIV/AIDS, and drug-related deaths than other advanced countries.2

Health conditions could be broadly categorized as acute, with rapid onset and limited duration, or chronic, having a slow progression but long duration. Acute conditions required prompt treatment, but could be resolved in a defined period through procedures, a course of drug therapy, and other interventions. Those with only acute conditions in a given year accounted for 26% of the population and 15% of health care spending. Those with one or more chronic conditions, such as heart disease, stroke,

HBS Professor Michael E. Porter, Principal Associate Jorge Ramirez-Vallejo (Institute for Strategy and Competitiveness, HBS, and Professor at Universidad de los Andes), and Research Associate Alexandra Houghtalin prepared this case. This case was developed from published sources. Funding for the development of this case was provided by Harvard Business School and not by the company. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management.

Copyright © 2016, 2017 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-

diabetes, and emphysema, accounted for 46% of the population and 84% of health expenditure, including any acute care needed for these patients.3 Healthy patients with no visits to a medical care provider in a given year accounted for 27% of the population and 1% of health expenditure. By age group, the elderly, most of whom had at least one chronic condition, accounted for approximately 14% of the total population and 31% of health care spending. The number of elderly was expected to double by 2050. Prescription drug spending accounted for approximately 10% of direct health care costs, with chronic conditions accounting for the majority of prescriptions filled.

Some complex conditions, such as hepatitis C, multiple sclerosis and cancer, required what were termed specialty drugs. These were typically expensive drug therapies that required special handling (e.g., refrigeration), administration (e.g., injection or infusion), or active monitoring for serious side effects. Some specialty drugs taken as pills or injections could be safely self-administered by the patient with pharmacist support. Others, such as those involving infusions, needed to be administered by health care providers. Traditionally this had taken place in hospitals, but was increasingly shifting to lower-cost outpatient settings or in the home.

Patients failing to manage their disease and adhere to medications or treatments were responsible for as much as $300 billion in avoidable health care costs annually. Studies showed that up to 30% of people never filled their prescription, and 50% did not take medications as instructed.4 Barriers to adherence included high cost, forgetfulness, difficulty coordinating refills of multiple prescriptions, and drug side effects, though side effects could often be reduced by switching drugs or altering dosing. Non-adherence, combined with medication errors and adverse drug reactions were major contributors to 30-day hospital readmission rates.

Unhealthy behaviors, such as lack of exercise, poor nutrition, tobacco use, prescription drug abuse, and alcohol misuse were major drivers of chronic disease. Alcohol misuse accounted for approximately 90,000 deaths each year (3.4% of all deaths). The 15% of adults who smoked cigarettes accounted for more than 480,000 deaths annually (18% of all deaths) and nearly $170 billion in direct medical costs.5 Obesity accounted for another $190 billion in annual health care costs, with the U.S. registering the highest obesity rate among high-income countries at over 30%.

Prevention, aimed at modifying unhealthy behaviors or delivering preventative interventions such as vaccines, could have major benefits for health and costs. After one year of not smoking, for example, heart attack risk dropped sharply. After 2 to 5 years, the risk of stroke was similar to a nonsmoker.6 Prevention was challenging, with 7 in 10 smokers trying to quit each year, but with only an estimated 6% success rate. These challenges helped explain why preventative care accounted for less than 4% of total health care spending. However, the chances of quitting doubled with counseling or medication.

The Health Care Delivery System

Private health plans covered about 55% of the population, mostly offered through employers with some payment contribution by employees. Government programs (Medicare and Medicaid) covered the elderly and low-income populations, respectively, accounting for 3 in 10 Americans and 35% of total health care spending. The private insurance industry had been consolidating since 2010. The cost of insurance was being shifted to patients through higher premiums, deductibles, co-pays and co- insurance. The proportion of employer sponsored health plans with high annual deductibles (higher than $1,000) had risen from 16% in 2006 to 61% in 2014.7 An increasing proportion of plans included tax advantaged medical savings accounts to deal with expenses not covered by insurance.

The Patient Protection and Affordable Care Act (ACA) had been enacted in 2010, making health insurance more accessible. The rate of uninsured nonelderly Americans declined from a high of about 18% to 11% (roughly 34 million people) by 2015. In 2013, the uninsured paid nearly $26 billion out of pocket for care, but accounted for $85 billion of uncompensated care. Many uninsured individuals also postponed needed care (32%) or went without it due to cost (27%).8

The health care delivery system consisted of more than 6,000 hospitals, 220,000 physician offices, and 27,000 outpatient care centers, but was consolidating. Primary care physicians provided general care. Specialists focused on particular disease areas and services (e.g., cardiology, radiology, or pediatrics). Multiple specialists were often involved in care for a single condition such as diabetes or cancer, resulting in care processes that were often complex and poorly coordinated. Specialists typically practiced in separate departments or physician practices, so that patients had separate appointments with each specialist, often leading to long waiting times. Electronic health records (EHR) were often not integrated across provider units, and responsibility fell to the patient to ensure that medical records, lab results, and prescriptions reached the proper provider.

The entry point for patients in the health care system was normally a primary care provider (PCP), who would treat common illnesses, diagnose conditions, refer patients to specialists, and provide preventive services. Most PCPs practiced in offices or outpatient centers with normal business hours and limited availability on nights and weekends. There was a growing shortage of PCPs, and it could be difficult for new patients to get an appointment. In Massachusetts, for example, more than half of primary care practices were not taking new patients. For those that did, the wait time for non-emergency appointments was around 40 days.9 Over half of Americans without insurance did not have a PCP.

Non-physician providers were involved in a growing amount of care. Registered nurses (RNs) could provide a range of care with physician supervision, while nurse practitioners (NP), nurses with master’s-level additional training, could write prescriptions and were qualified to provide 80%–90% of the care provided by a primary care physician. Physician assistants (PA) received master’s-level medical training, and could write prescriptions and provide similar care to NPs. Care by NPs and PAs could deliver primary care outcomes comparable to those of physicians at 20%–35% lower cost.

In 20 states, NPs could practice independently and operate their own primary care practice. Other states required varying levels of physician oversight. For example, in Alabama, a supervising physician needed to be present for at least 10% of an NP’s scheduled hours, while in Indiana, a physician was required to review 5% of an NP’s charts. PAs needed physician oversight in all states, but supervisors could be based elsewhere with oversight via email and phone. Eleven states had no restrictions on the number of PAs a physician could supervise, while some states had limits of 2:1. New legislation was reducing or removing physician oversight restrictions that prevented NPs and PAs from practicing to the full extent of their training, which could significantly reduce the PCP shortage and cost.10

Convenience, inability to secure a PCP appointment, and cost were the most common reasons patients cited for seeking primary care from somewhere other than a primary care office. About 30% of care for acute conditions (more than 50% for the uninsured) took place in hospital emergency rooms, as well as a substantial amount of care for chronic conditions.11 Emergency rooms were required by law to treat all patients regardless of ability to pay, and emergency room care accounted for about $160 billion of health care spending in 2015.12

Patient-centered medical homes were a variation on primary care in which PCPs took responsibility for coordinating patient care across settings and providers, assisted by care coordinators. Payment was largely on a fee-for-service basis, but was augmented with bonuses based on overall quality metrics. Primary care clinics led by nurse practitioners were also growing, focused on underserved communities.

Reimbursement to providers was largely on a fee-for-service basis, where each provider was paid separately for each service delivered. Fees varied by type of insurance, with Medicare and Medicaid reimbursement lower than private insurance. Insurers used various mechanisms to control spending, such as prior authorization for certain treatments or requiring use of lower cost generic drugs. Services such as follow-up calls or informal consultations to avert an office visit were not reimbursed.

Reimbursement for health care was in a state of flux. Accountable care organizations (ACOs) were paid a risk-adjusted single fee per covered life (capitation) and were incentivized to control cost, follow clinical guidelines, and improve care coordination. Over 700 ACOs had been established by 2015. Fee- for-service was also being supplanted by value-based payments for care of particular conditions (bundled payments). A bundled payment covered all the procedures, tests, drugs, and services involved in caring for a condition, such as joint replacement or heart failure, as well as for related complications and readmissions. Bundled payments were contingent on achieving good outcomes, rewarding value rather than volume of service. Large employers including Walmart and Pepsi were negotiating bundled payment agreements with leading hospital systems for specific conditions. Walmart employees, for example, could receive care at any of six “centers of excellence” for complex cardiac conditions, including reimbursement for the cost of a companion accompanying them.

Emerging Health Care Delivery Models

Employers had created wellness programs including convenient and low cost primary care clinics, on-site fitness centers, and other programs to support and incentivize healthy behavior. An estimated 30% of businesses with 5,000 or more employees had established near- or on-site health clinics for employees enrolled in the company’s health plan. Independent companies operating worksite health clinics included Premise Health (formerly owned by Walgreens), HealthStat and QuadMed. Clinics were staffed by physicians, RNs, NPs or PAs to handle minor acute care, wellness services, chronic disease management, health coaching, physical therapy, and pharmacies. Through lowering annual health costs, employers realized a return on investment on these clinics in as little as two years.13

Urgent care centers were freestanding physician offices with extended hours that saw patients on a walk-in basis. These had grown at an annual rate of 8% from 2000 to 2010, versus -1.2% and 1.4% for hospitals and physician offices. Urgent care addressed simpler acute conditions and acute exacerbations of chronic conditions, providing a range of services including on-site x-ray machines and laboratory testing. About half of urgent care centers were staffed by physicians trained in emergency medicine. There were approximately 7,000 urgent care centers in 2015, with the vast majority part of independent organizations operating 1–2 clinics. There was growing investment in urgent care, including significant private equity funding. Health insurers and hospital systems had begun establishing networks of urgent care centers, sometimes in partnership with urgent care operators, to divert lower acuity patients from the emergency room.

Retail health clinics, located in drugstores or mass merchants, offered convenient locations, hours, and walk-in access. These offered a narrower scope of services than urgent care centers. The number of retail clinics had grown 33% annually since 2006. There were over 2,000 nationally in 2015, with 95% in retail pharmacies, mostly located in densely populated urban and suburban areas.

Retail clinics were typically staffed by NPs and PAs to diagnose and treat minor acute conditions, perform health screenings and deliver vaccinations. Clinics were adding services to monitor common chronic conditions and provide wellness support such as weight management. An estimated 13%–27% of existing emergency room visits could take place at an urgent care center or retail health clinic, saving a potential $4.4 billion annually.14 The most common reasons for choosing a retail clinic were convenient hours (59%), walk-in service (56%), convenient location (48%), low cost (39%), and the lack of a primary

care physician (25%). In 2014, about 22% percent of adults reported visiting a retail health clinic.15 Most clinics accepted public and private insurance, as well as cash payments.

A clinic typically served 10 to 30 patients per day, and averaged $40–$75 per visit and about $500,000 annually, with an investment of $50,000 to $250,000 to build. The average cost of care for a common condition was $110 at a retail clinic, versus $156 at an urgent care center, $166 at a physician office, and

$570 in an emergency room, with the retail clinic providing as good or better outcomes.

Retail clinic operators were forming affiliations with regional health systems across the country. While some affiliations were mostly focused on fulfilling NP and PA oversight requirements, others involved joint protocols, co-branding, and two-way referrals. Many retail clinics had linked electronic medical records with affiliates to support deeper clinical relationships and better coordination. Health plans were increasingly adding retail health clinics to their provider networks.

New technologies were also changing delivery models. Patients could access health care practi- tioners through videoconferencing (telemedicine) that allowed providers to virtually diagnose patients and prescribe treatment. Average telemedicine costs were $40 to $50 versus $140 to $180 for a similar in-person visit, and reimbursement for these services was expanding. New medical devices were being developed to enable remote patient diagnostics and monitoring, such as wearable patches to diagnose heart conditions or sensors that could monitor medication intake. New digital platforms integrated patient information and helped patients adopt healthier habits, such as diet tracking.

History of the Retail Pharmacy Industry

Drugstores, or retail stores with pharmacies, were among the oldest type of retailing and had long been part of health care. They were found in nearly every town, and pharmacists were essential advisors on medicines and treatments. The industry was historically dominated by small neighborhood stores. Among the earliest chains were Pennsylvania-based Eckerd Drugs, founded in 1898, and Chicago-based Walgreens, founded in 1901. Walgreens had long been the industry leader and innovator, pioneering more appealing displays, a wider range of non-pharmacy or “front of store” merchandise, and soda fountains. The drugstore was a social center where patrons gathered.

Drugstore chains began to grow rapidly in the 1920s, with Walgreens reaching 400 stores in 87 cities by 1929. Chains reaped efficiencies in purchasing and advertising and offered better prices. By 1940, chain stores accounted for almost 25% of industry sales.16

In the years following World War II, the number of drugs available grew dramatically, and the pharmacy component of the drugstore expanded. In 1951, new legislation classified which drugs needed a doctor’s prescription and were only available through a licensed pharmacy, versus those sold over the counter (OTC).

Walgreens pioneered the self-service model in drugstores starting in the early 1950s, leading to lower prices and a wider product mix. In the 1950s, leaders like Walgreens refurbished and expanded existing stores, often doubling the square footage. In the late 1950s, Walgreens led the expansion of drugstore chains into suburban shopping centers.

Traditionally, consumers paid for drugs out of pocket, with insurance covering less than 5% of costs. Discount drugstore chains offering low prices emerged in the 1960s, including Rite Aid and Consumer Value Stores (now CVS) in 1963. Mail order pharmacies also emerged, competing on low prices. In the late 1960s, mass merchants such as Kmart began adding pharmacies. By the end of the 1960s, seven of the top 10 grocery store chains also operated in-store pharmacies.

Experiencing growing competition, drugstore chains including Walgreens diversified, entering restaurants, department stores, and other businesses. Walgreens divested all its non-core businesses by the end of the 1970s. By the late 1970s, Walgreens was the clear leader in the Midwest, Rite-Aid in the East, CVS in the Northeast, Revco in the Mid-Atlantic and South, Eckerd in the Southeast, and Rexall in small towns. California was more fragmented. By the end of the decade, drugstore chains accounted for over 50% of all retail pharmacy sales.17

Pharmacy Benefits Management

In 1967, Ford Motor Company struck a deal with the United Auto Workers to add prescription drug coverage to employee benefits. Pharmacy benefit managers (PBMs) emerged in the 1970s to manage the high volume of paper-based drug insurance claims, which neither pharmacies nor health plans had the capacity to process. PBMs reimbursed pharmacies for dispensed drugs on behalf of health plans. Express Scripts, a standalone PBM, was founded in the mid-1980s and went public in 1992. Several major pharmaceutical companies acquired PBMs in the early 1990s, and drugstore chains began acquiring or developing in-house PBMs by the mid-1990s, with Eckerd an early leader.

Prescription drug costs began to rise, more than doubling in the decade beginning in 1980. Legislation was passed to speed the approval of lower cost generic substitutes for branded drugs with expired patents. By 1987, one-quarter of all prescriptions were generic.

Computerized pharmacy dispensing, check-out, and logistics emerged in the late 1980s. Walgreens was the first to connect data across stores and became a leader in information technology. In the early 1990s, PBMs began adding data analytics to avoid adverse drug interactions, monitor the prescribing habits of doctors, and watch for wasteful or fraudulent behavior.

A non-retail pharmacy channel emerged to serve institutions such as long-term care facilities. Growth of mail order pharmacies accelerated, driven by rising drug costs, and health systems and insurers also began establishing mail order pharmacies. By the mid-1990s, all of the large drugstore chains offered mail order via automated, centralized mail facilities. Mail order prescriptions were typically a 90-day supply (versus 30 days), which was cheaper for both the consumer and insurer.

In the 1990s, PBMs developed tools to manage pharmacy costs through formularies that determined which drugs were reimbursable at what price, and through incentivizing the use of generics. PBMs negotiated with drug manufacturers on formulary lists and drug price rebates shared by the PBM, insurer, and employer. Retail pharmacies negotiated to be part of a PBM’s retail network where patients could pick up prescriptions. Retail pharmacies negotiated prices with PBMs, as well as per- prescription dispensing fees. Most PBMs also established mail order pharmacies to dispense drugs directly to patients, allowing the PBM to capture the dispensing margin and dispensing fee.

Approval of expensive specialty drugs had been rising since the 1970s, which were administered by infusion in hospitals and covered by health insurance, not drug benefits. Starting around 2000, a growing number of specialty drugs could be self-administered orally or by injection, and accessed through pharmacies. Health plans began shifting self-administered specialty drug reimbursement to drug benefits managed by PBMs, who were adept at negotiating lower prices.18 Traditional retail pharmacies faced challenges meeting regulatory standards and providing the needed clinical support for specialty drugs, such as 24/7 phone consultations by pharmacists with disease-specific training. Focused specialty pharmacies proliferated, and an accreditation system emerged to ensure quality. The specialty pharmacy channel consolidated rapidly, with large PBMs, drug wholesalers, health systems and chain drugstores all participating. Specialty drugs were the largest industry growth area by the mid-2000s. The market was expected to grow from $55 billion in 2005 to $400 billion by 2020.19

Industry Consolidation

In the early 1990s, Walgreens led the move of chain drugstores from inside shopping centers to freestanding convenience locations on the corners of shopping center parking lots or at main intersections featuring drive-through windows. Freestanding stores generated 25%–30% more revenues from front of store merchandise than stores in shopping centers.20 Items were strategically located in stores to facilitate purchases of related goods and encourage impulse purchases, such as candy placed near the register. Walgreens offered a larger selection of seasonal and holiday related merchandise than rivals. By 1998, over half of Walgreens stores were freestanding versus less than 25% at CVS.

A wave of drugstore mergers and acquisitions began in 1996. Chains emerged with 40% of prescription sales, mail order pharmacies 13%, mass merchants and grocery stores each 10%, and independents 27%. Walgreens, Eckerd, Rite Aid and CVS accounted for 65% of chain drugstore revenue. In the late 1990s and early 2000s, Walgreens grew organically, focusing on adding the most convenient locations. CVS grew mostly through mergers and acquisitions. Eckerd was broken up and sold to CVS and the Jean Coutu Group, and Rite Aid registered lagging performance (see Exhibit 1).

In 1999, CVS became the first to allow customers to order prescriptions online through its pharmacy benefits management division and choose whether to pick them up in one of its retail stores or have them delivered by mail. In 2001, CVS introduced its loyalty program, ExtraCare that provided coupons and incentives. Electronic prescriptions sent directly from a provider to the pharmacist became prevalent in 2001, saving about $11,000 per pharmacist annually.21

In 2006, prescription drug costs hit 10% of total health care spending, up from 6% a decade earlier.22 In 2006, Medicare Part D was introduced to provide drug coverage for enrolling seniors. Walmart, who served many uninsured, began offering 30-day supplies of generic prescription drugs for $4 in 2006, expanded to 90-day supplies for $10 in 2008. Mail order pharmacy volumes declined as more drugstores started filling 90-day prescriptions.

In 2007, Walgreens acquired Take Care Health Systems which added 360 on-site employer health clinics and pharmacies, and also opened over 600 new retail stores. In 2008, both Walgreens and CVS bid to acquire 520 Long’s Drugs stores, mostly in California, and CVS won. In 2010, Walgreens acquired the Duane Reade chain with 260 stores in the New York City area. Walgreens and CVS continued to rapidly add stores through both acquisitions and organic growth.

Beginning around 2012, insurers began shifting to preferred and limited retail pharmacy networks to lower drug costs. Pharmacies negotiated lower prices for inclusion in either a select group of preferred pharmacies with lower co-pays than the broader network, or a limited network that only included low-cost pharmacies. Nearly 85% of Medicare Part D plans used a preferred network.

In 2012, Express Scripts became the nation’s largest PBM. The same year, a contract dispute led to the exclusion of Walgreens from Express Script’s retail pharmacy network for most of the year, resulting in multi-billion dollar losses for Walgreens.

Generic drug penetration had been rising for decades with fewer brand name drugs approved. By 2014, the industry was approaching the maximum feasible generic substitution rate. At the same time, a rising number of prescription drugs, such as allergy medications, were being approved for over-the- counter availability. Older generic drugs generally experienced decreasing margins.

In December 2014, Walgreens merged with leading European chain Alliance Boots, which described itself as a “pharmacy-led health and beauty company.” The new company was named Walgreens Boots Alliance, and operated in 25 countries with 12,800 stores and 370,000 employees.

In 2015, driven by specialty drugs and rising prices, drug spending rose by an estimated 8%, versus 6% for overall health spending. Drug manufacturers had faced public scrutiny in response to dramatic price increases for some existing drugs. Drug company executives were beginning to blame PBMs for rising prices, arguing that percentage-based rebates negotiated by PBMs encouraged larger price increases. PBMs claimed that the rebates reduced overall cost, as PBMs competed aggressively to lower drug costs for their clients, typically large employers and health plans. 23

Expanding Pharmacy Services

Early pharmacists routinely diagnosed common ailments and recommended medicines. After World War II, physician pressure led Walgreens to ban pharmacists from diagnosing patients.24 Although pharmacists continued to be involved in preventive care, health and wellness, the role of the pharmacist was centered on dispensing prescriptions and checking for drug interactions.

Since the mid-1990s, pharmacists in some states could deliver vaccinations. It was not until the H1N1 flu pandemic of 2009, however, that this practice became widespread. By 2014, every state allowed pharmacists to administer vaccinations and over 75% of pharmacies offered this service.25

In 2003, Medicare Part D prescription plans began reimbursing for medication therapy management, a pharmacist-delivered service that included counseling and medication reviews to avoid adverse drug interactions, simplify regimens, and reduce side effects. Reimbursement was low, however, and busy pharmacists were challenged to devote sufficient time to such services.

Drugstore chains began operating health clinics in stores in 2005, starting with CVS’ partnership and later acquisition of MinuteClinic. From 2006 to 2015 the number of retail health clinics grew from 200 to 2,000. By 2015, all large drugstore chains operated clinics, as did several mass merchant and grocery stores.

Given that many drugs and treatments such as hydration and enteral nutrition (feeding tube) were administered by infusion, companies emerged offering in-home infusions or in outpatient clinics at significantly lower costs. In 2004, 6% of chemotherapy infusions were administered at home or in an outpatient clinic, versus 50% by 2014. Non-hospital infusion services had grown from an estimated $5 billion in 2005 to $11 billion by 2014.26 Drugstore chains entered infusion services, which had higher margins than specialty pharmacy.27 In 2007, Walgreens acquired an infusion services company.

In 2010, the Hospital Readmissions Reduction Program created by the Affordable Care Act began penalizing hospitals with high 30-day hospital readmission rates for Medicare patients. Leading drugstore chains partnered with health systems to reduce readmission rates through pharmacist medication counseling upon discharge. Readmission rates for those patients began to fall in 2012.

Drugstore Chains in 2015

Drugstore chains had total sales of approximately $250 billion in 2015, with a five-year annual growth of 1.0%.28 Few regional drugstore chains were left in 2015. CVS, Walgreens and Rite Aid accounted for over 85% of drugstore chain locations, with 28%–30% overall gross margins versus an average of 24% for all pharmacies.29 Drugstore chains were the dominant prescription retailers with 40% of total

prescription revenues, competing with independents (15%), mass merchants (10%), grocery stores with pharmacies (9%), and standalone PBMs and mail-only pharmacies (26%).

Retail stores Nearly 90% of Americans lived within five miles of a drugstore location.30 Freestanding convenience stores had become the industry standard. Convenience was a key driver of sales for chains, as well as for grocery stores with pharmacies, and independents. Mass merchants competed primarily on price and one-stop shopping.

On average, drugstore chains generated two-thirds of their total revenue from prescriptions, compared to 90% for independents and 5-10% for mass merchants and grocery stores. About 85% of prescriptions dispensed by volume in 2015 were generics.31 Branded drugs typically generated $200–

$250 in revenue per 30-day prescription, with a gross margin of 5%–10%, versus $10–$25 for generics, with a gross margin of 50%–60%. Margins were higher for uninsured customers paying out of pocket. Per prescription dispensing fees averaged $2 for both generic and branded prescriptions in 2015. Retail pharmacies were also paid fees for performing various services, such as medication review.

Chain drugstores generated 30 to 40% of their revenue from front of store merchandise, with major product categories including beauty, groceries, OTC drugs, and general merchandise (e.g., seasonal items, mobile accessories, magazines). Front of store merchandise provided average margins of approximately 40%.32 Beauty margins were about 1.5 times higher than other front of store categories.

Chains used customer relationship management (CRM) software and data analytics to track customer behavior and purchasing patterns. IT systems were mostly integrated across retail, mail, specialty, and service units. Workflow management software for pharmacists provided patient and drug information to enable better patient interactions. Dispensing was becoming more automated.

Pharmacies sourced drugs from wholesalers, who negotiated prices with manufacturers for bulk shipments and distributed to warehouses or directly to stores or mail order centers at marked up prices (see Exhibit 2). The leading wholesalers were McKesson, AmerisourceBergen, and Cardinal Health, who distributed over 85% of all drugs nationally. In 2014, 75% of total gross profits for the top three wholesalers came from generics. As pressure on generic profitability grew, the three largest drugstore chains each formed generic purchasing agreements with the three largest wholesalers.

Mail order Drugstore chains operated large, centralized, automated, mail order facilities. Standalone PBMs, health plans, grocery stores and mass merchants also operated mail order pharmacies, which had higher margins than retail dispensing. CVS and Express Scripts together accounted for about 75% of total mail order revenue. Customer co-pays were often lower for mail prescriptions, a primary reason for choosing mail delivery. Prescription orders could be called in, placed online, or increasingly transmitted through proprietary mobile apps. Over 75% of retail pharmacies, and all the large chains, could process electronic prescriptions by 2015.

PBM services PBMs managed drug benefits for more than 210 million Americans. PBMs were paid service fees by health plans, but most profits came from dispensing generic drugs through the PBM’s mail pharmacy, which provided a gross margin of about 25% versus 5% for generics dispensed through the PBM’s retail pharmacy network. The largest PBMs were Express Scripts (28% market share), CVS (27%), UnitedHealth (10%) and Catamaran (7%).33 Only two drugstore chains, CVS and Rite Aid, had PBMs in 2015. The large standalone PBMs had no plans to enter the drugstore business.

Specialty pharmacy services Most large drugstore chains operated dedicated specialty mail order pharmacies, and some also had specialty retail locations. Specialty pharmacies were also operated by PBMs, health plans, drug wholesalers, and health systems.

Health services Leading chains had introduced programs to enhance patient drug adherence, such as pharmacist counseling, follow-up on unfilled prescriptions, and coordinated refills. Most retail pharmacists also administered vaccinations. Drugstore chains operated the large majority of retail health clinics. The scope of services was similar across companies (see Exhibit 3), but some offered more health management and ongoing care. Most retail health clinics had partnerships with local health systems. Some drugstore chains had infusion services businesses.

Competitors

In terms of retail prescription drug revenues, CVS was the industry leader at 25% in 2015, followed by Walgreens Boots Alliance with 22%, Express Scripts (standalone PBM) with 12%, Walmart (mass merchant) with 6%, Rite Aid with 6%, and Kroger (grocery store) with 3%. Independents had a cumulative share of 15%. (See Exhibit 4 for historical stock performance.)

Walgreens Boots Alliance Walgreens Boots Alliance (Walgreens) was the largest U.S. drug- store chain by store count in 2015, with over 8,300 drugstores covering every U.S. state. Drugs accounted for 64% of revenue. Walgreens described itself as “the first global, pharmacy-led health and wellbeing company.” Top management was drawn heavily from former Boots executives, and the company was undertaking a major restructuring of its U.S. operations to cut $1.5 billion in costs. Management described the U.S. growth strategy as a “back-to-basics” approach focused on convenience, pharmacy modernization, and customer care.

Walgreens average retail location was approximately 11,000 square feet, and the company was remodeling stores in a new “well experience” format that aimed to make Walgreens stores a “health and daily living destination.” New features included a manicurist, smoothie station, and sushi bar. By 2015, 700 stores had been converted.

The company was expanding front of store revenue, informed by Boots international success in beauty products. Walgreens was increasing seasonal gift items priced less than $20, stocking staple foods for fill-in grocery trips, offering more “instant consumption” items such as candy, and stocking ubiquitous mobile accessories like phone chargers.34 Walgreens had opened “LOOK boutiques” at key locations featuring expanded ranges of low to mid-range cosmetics as well as higher-end U.S. and European brands not typically found in drugstores (including the popular Boots No. 7 brand).

A loyalty program with 86 million active users allowed customers to earn reward points for shopping, filling prescriptions, logging healthy behavior in a mobile app, and quitting smoking. Data- informed stocking decisions across stores. Overall, upgrading IT systems was a key priority.

Walgreens’ specialty drug sales accounted for $8.5 billion or 11% share of the patient-administered specialty drug market. Approximately two-thirds of its specialty prescriptions were filled through retail stores, with the balance filled by mail. Walgreens’ infusion services business had grown to over 100 standalone infusion clinics in 40 states with nearly 5,000 employees.35 In January 2015, Walgreens sold its infusion services business, but planned to keep close ties with the now independent business.

In 2012, Walgreens began focusing on improving medication adherence through pharmacist counseling. The company’s program to reduce hospital readmissions offered particularly extensive services, including inpatient medication delivery, and reported a 46% reduction in readmissions.36

Walgreens had divested its controlling interest in Take Care Employer Solutions, which operated over 270 on-site employer health clinics. Walgreens operated 400 Healthcare Clinic locations in 5% of its stores in 2015, representing 23% of the total retail health clinic market. Healthcare Clinic had formed

clinical affiliations with six health systems and planned to add more. Late in 2015, 35 of the clinics were closed or operated with shortened hours. The company partnered to open 25 new independently operated clinics in Walgreens stores and was pursuing other similar collaborations.

Following CVS’ move to stop selling tobacco, Walgreens began offering online smoking cessation tools and pharmacist counseling on nicotine replacement medications. Walgreens partnered to create an online and mobile platform that facilitated at home telemedicine appointments for minor acute conditions, as well as smoking cessation counseling and prescriptions. Walgreens was also exploring an online platform partnering with DermatologistOnCall to offer telemedicine dermatology.

Express Scripts Express Scripts was the largest PBM and managed the drug benefits of over 85 million individuals. Express Scripts did not operate retail stores, and its retail network included nearly all pharmacies. Customers could also fill prescriptions through Express Scripts’ mail order pharmacy. The company’s Accredo specialty pharmacy subsidiary also offered infusion services.

Walmart Walmart was the world’s largest company by revenue, operating more than 4,200 retail pharmacies in 49 states and accounting for about 70% of pharmacy sales by mass merchants. Pharmacy sales accounted for an estimated 4% of total revenue.37

Walmart stores were large and carried a wide line of merchandise, including groceries, at guaranteed low prices. Its pharmacy competed aggressively on price and offered an industry leading generic drug discounting program. Walmart did not operate a PBM business.

Walmart had started leasing space in its stores to independent health clinic operators in 2006, planning to reach 2,000 clinics by 2014. Many of these clinics had not been profitable and only 73 remained in 2015.38 One independent operator commented, “to make the clinic business profitable, you need to have more than just a clinical encounter. You also need to sell the patient prescriptions, a bag of chips, and maybe a magazine while they’re waiting.”39

Starting in 2014, Walmart opened 17 company-operated Care Clinics staffed by NPs in Texas, South Carolina and Georgia, which were states with physician shortages and relatively high rates of uninsured. It had partnered with QuadMed, a private health clinic company, to recruit and train NPs and establish physician oversight affiliations. Care Clinics were marketed as primary care clinics, and about 40% of customers did not have a PCP. The cost was $40 per visit ($4 for Walmart employees).

Rite Aid Rite Aid was the third-largest drugstore chain by 2015, with over 4,500 stores with an average size of 12,500 square feet across 31 states. Prescription drugs sales accounted for 69% of revenue, mostly dispensed through drugstores. Half of stores included an independently operated store-within-a-store selling vitamins and supplements. Rite Aid had been trimming underperforming stores and was remodeling stores in a new “wellness” format that expanded health products and added “wellness ambassadors” to assist customers and act as a liaison to the pharmacy.

Rite Aid launched a program in 2015 to coordinate prescription refills. In 2015, it acquired EnvisionRX, a small PBM, for $2 billion. Rite Aid was considering a limited network drug benefit plan matching CVS’ Maintenance Choice program.

Rite Aid acquired Health Dialog in 2015 that offered health coaching services and health analytics. The Rite Aid Health Alliance program partnered with local health systems to offer health coaching and chronic disease management services provided by pharmacists and care coaches in Rite Aid stores. Another partnership with Heritage Provider Network, a physician network in Southern California, provided patients with adherence counseling, nutrition and weight management advice, exercise coaching, and tobacco cessation support in Rite Aid stores.

Telemedicine kiosks were being piloted in 25 retail locations in Ohio to treat a limited number of minor acute conditions. The kiosks were fully enclosed booths that connected to a physician through videoconferencing and included diagnostic tools such as thermometers and in-ear cameras that sent results directly to the physician in real time.

Rite Aid acquired Texas-based RediClinic in 2015, an operator of 50 retail health clinics in Rite Aid stores and 30 clinics in HEB grocery stores. It partnered with the top health system in each market it served. HEB RediClinics had developed a weight management program that included physical exams, tailored nutrition programs, pedometers, exercise routines, and also provided grocery lists and directed patients toward healthy food located within the grocery store. The program had produced average weight loss results of one to two pounds per week.

Kroger Kroger was the largest grocery store chain in the U.S., with over 2,000 in-store pharmacies, accounting for 8% of revenue. Kroger had a full service specialty pharmacy and a PBM, neither with significant market share.40 Kroger operated over 175 in-store Little Clinics in nine states.

Independents Independent drugstores, mostly concentrated in rural areas, still accounted for one-third of pharmacy locations but were less profitable and slowly losing market share. About 90% of revenue came from prescriptions. Most independent drugstore locations were significantly smaller than chain drugstores and had lower prescription volume. Most independents offered same-day delivery as well as charge accounts, which were not typical at chains. Independents did not compete in PBM or mail order except on a small scale. Independents had the shortest wait times to fill prescriptions and the highest customer satisfaction ratings.

A few independents operated retail clinics, but most did not. In 2015, “1-800-Pharmacy” and the Independent Pharmacy Cooperative launched the Virtual Healthcare Clinic program to provide in- store or at-home telemedicine via the patient’s smartphone for a fee of $50 per session. The telemedicine doctor sent prescriptions directly to the independent pharmacist to be filled.

History of CVS

The first Consumer Value Stores (CVS) location was opened in Massachusetts in 1963 as a discount health and beauty retailer. In 1967, CVS began adding pharmacies. With 40 stores in 1969, CVS was acquired by Melville Corporation, the nation’s largest shoe retailer, which had been diversifying.

By 1974 the CVS business unit reached $100 million in sales, with 45 of its 232 stores including pharmacies. CVS continued to grow, added PBM services in 1994, and was Melville’s top performing business unit, accounting for 40% of revenue by 1995. Melville sold or spun off its non-pharmacy businesses in 1996 to focus on drugstores and the company was renamed CVS Corporation.41

In 1997, CVS acquired Revco for $3.7 billion, adding nearly 2,600 stores in 17 states, including many outside its Northeast territory. CVS emerged from the Revco deal with the most retail stores, but ranked behind Walgreens in revenue. CVS was also aggressively opening new store locations. By 1998, 25% of stores were in freestanding locations with a plan to ultimately reach 70%–80%. Tom Ryan became the CEO in 1998. In 1999, CVS launched the CVS ProCare specialty pharmacy. In 2000, CVS acquired Stadtlander Pharmacy to make CVS the largest specialty pharmacy operator.

In 2000, CVS revised its mission “to be the most customer-focused, innovative and convenient health care service retailer in America” and its vision “to help people live longer, healthier, happier lives.” A series of “CVS easy” initiatives were introduced focused on increasing convenience, such as improving store design and installing self-service digital photo printing kiosks.

In 2004, CVS completed a $2.2 billion partial acquisition of Eckerd, including 1,260 stores, a mail order business, and a PBM. CVS merged with PBM Caremark RX in 2007, increasing PBM to nearly 40% of revenue, up from 8%. In 2007, CVS was renamed CVS Caremark, which consisted of two major units, Retail Pharmacy and Pharmacy Services. The mission was revised to “provide expert care and innovative solutions in pharmacy and health care that are effective and easy for customers” and its vision to “strive to improve the quality of human life.”

In 2005, CVS entered into a partnership with MinuteClinic, an operator of 18 health clinics located in various retail stores. Tom Ryan described this move as the latest “CVS easy” initiative to increase convenience. In 2006, CVS acquired MinuteClinic, then consisting of 66 clinics in CVS stores and 17 in other locations with revenue of $8.6 million. CVS launched Project Health in 2006, a program in its retail pharmacy locations offering free health services, including health screenings, health insurance education, consultations with a pharmacist or NP, and medical referrals. By 2007, there were 460 MinuteClinics in CVS stores. Chris Bodine, then President of CVS Health Services, commented that “we’re so much more than just a pharmacy chain or standalone PBM. We’re going to play an important role in improving the delivery of health care services in the United States.”

Starting in the mid-2000s, CVS had been investing in research on medication adherence. In 2007, CVS introduced the First Fill Counseling program where pharmacists counseled customers about their treatment on the first visit to fill a new prescription. Data revealed a 15% improvement in adherence. In 2008, CVS launched the Maintenance Choice program, a limited network pharmacy benefit plan that offered customers the option to either receive 90 day prescriptions through the mail or to pick them up in a CVS retail store at mail order pricing. The program reduced costs for both health plans and consumers. Standalone PBMs chose not to match this service.

Larry Merlo became President and CEO of CVS in 2011, and defined a new corporate purpose, “helping people on their path to better health.” As part of the new direction, the Pharmacy Advisor Program was added as a PBM service to support drug adherence in diabetes patients through in-store and over the phone pharmacist counseling, plus automated email and text reminders to refill or pick up prescriptions. The program saved $3 for every $1 spent by health plans. Another new program focused on reducing hospital readmissions. CVS worked with hospitals to identify patients at risk for non-adherence and provided in-home or phone consultation upon discharge, including medication review and education, health coaching, and coordination with the patient’s primary care provider. In 2014, CVS acquired Coram LLC, a leading provider of specialty infusion and enteral nutrition services with more than 75 freestanding locations as well as in-home services.

As CVS expanded its health services, the sale of tobacco in its stores was limiting relationships with providers and health plans. Merlo convened leaders from across the company to consider the issue in light of the CVS’ strategy and purpose. In September 2014, the company changed its name to CVS Health and announced that it would stop selling cigarettes and tobacco products in its retail stores. It also launched a national smoking cessation program supported by CVS pharmacists and MinuteClinic nurses. The decision was expected to result in lost annual sales of approximately $2 billion and $300 million in profits. At the time of the announcement, CEO Larry Merlo commented:

For our patients and customers, health is everything and CVS Health is changing the way health care is delivered to increase access, lower costs and improve quality. Each year, CVS Health touches more than 100 million people by playing an active, supportive role in each person’s unique health experience and in the greater health care environment.

CVS in 2015

In 2015, CVS acquired Target’s 1,660 pharmacy and 80 health clinics and had over 9,400 retail stores.42 It employed more than 215,000 employees in 47 states and Puerto Rico, including 24,000 pharmacists, and 2,000 nurses, nurse practitioners, and physician assistants. Estimates of overall revenue consisted of front of store merchandise (12%), retail store prescription dispensing (32%), PBM and mail order dispensing (35%), specialty pharmacy (20%), and MinuteClinics (less than 1%).43

Approximately 72% of retail store revenue came from prescriptions. About 60% of CVS retail customers exclusively shopped for front of store merchandise and did not fill prescriptions. Increasing the ratio of shoppers who filled prescriptions was an important priority. In front of store, CVS was reducing its emphasis on categories like photo finishing and general merchandise. It held a 12% market share in beauty products and was looking to expand its line, particularly in natural products. The company was expanding its selection of “Better for You” food. A new private label food line, Gold Emblem Abound, included more than 40 wholesome snack choices. In-store signage directed shoppers to products meeting specific dietary needs, such as gluten-free or organic. CVS had plans to replace 25% of candy located near registers with healthier options.

ExtraCare was one of the most advanced loyalty programs, with approximately 70 million active users. The program used data analytics to generate targeted emails, coupons, and ExtraBucks Rewards, including incentives to fill prescriptions at CVS. Analytics were also used to adjust product mix and store arrangement. CVS had developed a mobile app where customers could manage their ExtraCare account, order new prescriptions and refills, receive alerts about prescription status, find a nearby CVS retail location, and shop for merchandise. CVS had rolled out beacon technology in its stores that could recognize a customer’s device running the CVS mobile app and send information such as whether prescriptions were due for refill. The “health engagement engine” analytics platform connected data from across CVS’ operations (retail stores, web and mobile, clinics, PBM) as well as data from outside partners such as affiliate health systems and from research studies.

CVS’ PBM processed 24% of all prescriptions filled nationwide, serving more than 2,000 health plans with over 75 million plan members. Caremark had won $11.5 billion in new contracts in 2015 and achieved 98% client retention. Caremark processed 35% of all the prescriptions dispensed at CVS stores, up from 12% in 2007, helped by the Maintenance Choice program. Following its decision to remove tobacco products from stores, Caremark introduced pharmacy benefit plans that charged higher co-payments for filling prescriptions at pharmacies selling tobacco.

In May 2015, CVS acquired Omnicare, the leading provider of drugs to long-term care facilities, with revenues of $4.8 billion and access to the fast growing non-retail prescription market. In 2015, CVS became the largest specialty pharmacy in the U.S., with revenues of $29.6 billion and a 27% share of patient-administered specialty drug spending. It had 24 accredited specialty retail pharmacies and 11 specialty mail order pharmacies. About half of customers chose to pick up specialty prescriptions in CVS retail stores through the Specialty Connect program, versus receiving them by mail or in a specialty retail store. CVS Coram unit provided infusions in a patient’s home or at a lower cost outpatient infusion clinic to over 140,000 patients annually. The company was also piloting in-store infusion suites.

Health Services

CVS had set a goal of raising customer medication adherence 15% by 2017. The Pharmacy Advisor Program had been expanded to support nine chronic conditions and had provided more than 10 million pharmacist counseling interventions since inception. A new feature added in October 2015 involved automated calls and text messages alerting patients to check their medication supplies ahead

of major weather events. The new ScriptSync program coordinated refills for patients with multiple recurring prescriptions to enable a single monthly pickup, improving adherence by 5 to 10% on average. CVS estimated that its adherence rates for diabetes, hypertension and cholesterol were approximately eight percentage points higher than other leading chains.

CVS was investing in digital health technology, finding that pharmacy customers with an account through its mobile app or website filled 2.4 times more prescriptions and were more adherent to medications on average. The Digital Innovation Lab was established in Boston to focus on digital health including personalization and smart, connected health products. Technologies in development included a mobile app offering incentives for logging medication adherence, and a remote diagnostic tool that sent video of a patient’s inner ear to a MinuteClinic practitioner for diagnosis. In late 2015 the Lab announced a partnership with startup accelerator MassChallenge and venture fund Rock Health to support Boston health technology startups.

As of 2015, CVS MinuteClinic was the largest and fastest growing chain of retail clinics, with five million patient visits in 2014 and about $300 million in revenue. There were over 1,100 locations, with 500 more planned. MinuteClinics provided the broadest scope of services versus competitors. In 2015, MinuteClinic launched the One-Time Medication Renewal program for patients who were having trouble accessing physician renewal of maintenance prescriptions. Patients could visit their local MinuteClinic to receive an assessment and a one-time 90-day prescription refill, allowing time to follow up with a physician. All CVS employees could receive free wellness services at MinuteClinic locations, including preventive health screenings, flu shots, and smoking cessation counseling. MinuteClinic had expanded its smoking cessation program, which included consultation with a nurse practitioner, a nicotine-dependence assessment, an individualized cessation plan, ongoing coaching, nicotine- replacement prescriptions, and communication with primary care providers.

MinuteClinic had also begun to utilize telemedicine to allow RNs to connect remotely to an NP or PA at another clinic to better utilize staff. In 2014, telemedicine services had been used in over 7,000 MinuteClinic appointments. In late 2015, CVS partnered with three telemedicine companies to pilot a program that would allow MinuteClinic patients to access telemedicine physicians. In Ohio, patients could access doctors at the Cleveland Clinic.

CVS had over 60 affiliations with leading regional health systems by 2015, with several more in the pipeline. Many affiliations took the form of clinical partnerships. For example, Emory Healthcare and MinuteClinic had jointly developed hypertension evaluation, treatment, and management protocols to be used at both Emory and MinuteClinic sites. Medical records were fully linked to better coordinate care between the two organizations. MinuteClinic was implementing the Epic EHR system used by many of its affiliates to allow easy records sharing.

In November 2015, CVS Health partnered with a nationwide coalition of physician organizations, the Health is Primary campaign, to promote coordination between primary care providers and retail pharmacies and clinics. The campaign disseminated patient materials, including a roadmap for when and where to access various types of health services.

Community Engagement

CVS had adopted a new social responsibility framework in 2013, focused on healthier communities, environmental sustainability, and economic opportunity (see Exhibit 5). The company and the CVS Health Foundation had made more than $95 million in charitable contributions in 2014, including volunteering, employee donations, and in-store fundraising. “Project Health” had invested more than

$81 million in free health care services to nearly 852,000 patients in 10 major metros across the U.S. since 2006, and had expanded its free smoking cessation support program in 2014.

CVS Health had pledged to reduce its environmental footprint, including truck routes, fuel efficiency, greenhouse gas emissions per square foot of retail space, and water use in landscaping. Recycling programs in stores diverted nearly 45,000 pounds of waste from landfills in 2014. CVS published its environmental outcomes, but the economic benefits of the efforts were not reported.

The company’s Pathways to Pharmacy program had introduced more than one million young people to careers in pharmacy since its launch in 2000. CVS provided scholarships worth $400,000 annually to pharmacy schools across the country and announced a plan in 2015 to double the size of its pharmacy technician apprenticeship program by 2020.

CVS Health supported cross-sector efforts including a national symposium with the American Public Health Association to reduce tobacco use, improve health, and reduce health care costs. CVS had provided more than $2 million in grants to organizations that discouraged smoking and helped people quit, and CVS was the main sponsor for the American Lung Association’s initiative to raise awareness of lung cancer as the leading cause of cancer deaths in women.

Looking Ahead

The retail pharmacy industry was facing growing reimbursement pressure, declining generic drug margins, and narrower pharmacy networks. Some physician groups, including the American Academy of Family Physicians (AAFP), had opposed the expansion of retail health clinic services, particularly into chronic condition management, on the grounds that this contributed to fragmentation of care and reduced provider accountability.

Traditional health systems were moving toward new care delivery models including walk-in urgent care clinics with lower prices than traditional care settings. Retail clinics were moving toward greater coordination and integration with nearby health systems.

In October 2015, Walgreens announced that it would acquire Rite Aid, citing complementary store locations and the ability to reap economies of scale. Pending expected antitrust approval, the deal would make Walgreens by far the largest U.S. drugstore chain by store count. CVS leadership had to decide how to respond and deal with a rapidly changing U.S. health care landscape.