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Late last month the Wall Street Journal broke the news that CVS and Aetna were in merger talks.  The quick take away by many who were quoted on the subject was that this deal is all about Amazon.  In other words, CVS was expanding its reach into traditional healthcare not only because more people are ordering health and beauty products online rather than making a trip to the local drug store, but also because Amazon is getting licensed in several states to begin selling prescription drugs.

In its most recent earnings announcement, CVS Health did not comment on the news, but clearly this potential deal raises all kinds of questions.  Is this really about Amazon?  What is it about acquiring Aetna that would enable CVS to compete more effectively with Amazon?  And what does this tell us about the future of healthcare and on-demand medicine? 



The bottom line is there are lots of moving parts to this potential merger.  So first, let’s look at the Amazon question.  

“If you look at the Amazon model, they have removed friction from retail,” says Fred LeFranc, one of our speakers at our January strategy symposium in Scottsdale.  LeFranc studies the consumer journey primarily in the hospitality industry. 

“You can buy anything on your computer.  You can do it on your phone.  And now with an Echo you can ask Alexa to do it for you.”

Ask yourself four questions from the consumer’s point of view:
– What do I need or want?
– When do I want it?
– Where do I want it?
– How much does it cost?

It’s a fact that Amazon has found a way to give consumers more options on each question, disrupting business for so many companies.  The volatility of retail stocks such as Walmart, Target or Best Buy are clues that the Amazon effect is real.  And within the drug store sector, another clue is the recent news that Walgreens is starting to lease a third of its store footprint to the MedExpress urgent care chain in several markets.  The drug retailer simply doesn’t need as much front-of-store space.  And having a strategic tenant like MedExpress bringing customers to a Walgreens location can only help.

A more precise way to calculate the potential Amazon effect at CVS is to look at their front-of-store sales as compared to prescription counter sales over the last several years.  For this analysis, we will use numbers from most recent quarter (Q2 2017) compared to the same quarter 10 years ago (Q2 2007).  Using Q2 also stays away from the holiday retail season, which skews up significantly.

Pharmacy counter sales as a percent of total store sales went from 67.6 percent in Q2 2007 to 74.6 percent in Q2 2017, meaning front-of-store sales (non-prescription drugs) dropped by seven percentage points over that period.  So one could argue that Amazon is having some impact on CVS’ front-of-store sales.   But to argue that CVS’ retail drug store business is weakening to a point that it would be the primary driver of the Aetna talks seems like a stretch.  

In the second quarter of 2007, CVS Pharmacy filled 134 million prescriptions in its retail pharmacies.  Ten years later in Q2 2017, CVS Pharmacy filled 235 million prescriptions at retail: an increase of more than 100 million prescriptions.  Operating profit for the retail store segment went from $727.8 million to more than $1.4 billion over that same period.  
So despite a small dent in the front of store sales percentage, CVS Health’s retail segment is very healthy.  And however CVS Health evolves in traditional healthcare, its retail experience and focus on the consumer experience will only serve as one more differentiator.
“CVS is figuring out how to remove friction and negative emotion in the healthcare experience,” says LeFranc.  “They are starting from a position of empathy and wellness.”  



The retail pharmacy segment at CVS is only half the story, and not necessarily the most interesting half.  The more compelling story is CVS Health’s pharmacy benefit management (PBM) business.  In Q2 2007, the PBM business had operating profit of $616.4 million on revenues of $10.6 billion; in Q2 2017 operating profit was $1.1 billion on revenues of $32.3 billion.

CVS Health’s PBM business is the largest in the country.  Through that business CVS Health has relationships not only with hundreds of regional and national health insurance companies, but with thousands of self-insured employers across the country and millions of covered lives.  Aetna is the third-largest health insurance company in the United States.  That means they, too, have relationships with thousands of employers and millions of covered lives.

What is it that employers most want?  Healthy employees (and dependents) and lower costs.  What will the future of healthcare revolve around?  Healthy populations and lower costs.  By acquiring Aetna, CVS would continue to grow its core business around lowering costs through population health management.  In this sense, the Aetna deal looks less about competing with Amazon in the retail sector and more about competing with the likes of Optum in the population health management sector.

“This is more about Optum than Amazon,” says Peter Martin, managing director at JMP Securities, an investment banking and asset management company based in San Francisco.  “I think they will both try to set up a deal with Amazon to be on Alexa as a pick up spot.”


Take a day at the office and survey the attendees at every meeting you attend on whether they have used Amazon.  By the end of the day you will realize Amazon already has basic information about most consumers.  So the potential to transform the healthcare experience is mind numbing, especially on the front-end of an office visit.

In late July, CNBC broke a story about an Amazon project called “1492” aimed at entering the healthcare space.  According to CNBC that entry would be more aimed at electronic medical records, data sharing and patient registration.  So at this point it is unlikely we would see Amazon get into the provision of healthcare services directly with patients.

Another way to think about Amazon is to think of the “big box” as more than a description of the building that houses a Walmart or Target store, or any number of shuttered commercial retail spaces around the country.  Instead, think of the big box as a metaphor for legacy ways of doing business.  Take IBM, for example.  The big box in their case was the mainframe computer.  They have spent decades reshaping their company in a way that makes them less dependent on the legacy sources of revenue that revolved around that mainframe computer.  
And when it comes to healthcare, of course, the big box is the hospital, and all of the ways that healthcare delivery revolved around that: in-patient revenue as the core of cash flow; how patients are billed; how physician groups are organized; how health insurance is structured; and even how government regulatory agencies are organized.  And when you go back to those four consumer-centric questions around time and space, traditional healthcare forces consumers to adapt to the doctor rather than the doctor adapting to the consumer.  That is where healthcare has become vulnerable to disruption.

The Amazon effect will continue to be debated and analyzed.  The bottom line is that you can talk all you want about giving consumers what they want.  But how you put that into scalable and repeatable daily operations is what ultimately will drive a consistent “wow” experience across every consumer touch point.

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