Another High Profit Industry Comes Under Assault

For many years now, large employers and governments have contracted with pharmacy benefit managers (PBMs) to provide and administer drug coverage for their employees. In turn, the PBMs tell the employers that they will pass on a good part of their purchasing economies to save the employers’ cost. This approach has worked well for the PBMs for years. They have been highly profitable businesses.

These high profits have attracted the attention of a new scary competitor, Wal-Mart (see “Video #3: Predicting the Direction of Margins” on StrategyStreet.com). Wal-Mart is offering businesses low-priced drugs if they sign up to have their employees purchase directly from Wal-Mart’s network of in-store pharmacies. Wal-Mart will offer these businesses a fixed mark-up over its cost for the drugs. While Wal-Mart will not reveal the cost of its purchases, it will have a third party verify the mark-up, thus guaranteeing the business of its deal. Wal-Mart benefits in two ways with this new business program. It guarantees a profit on each sale with its cost plus pricing. It also draws more customers into its stores where it has a chance to sell them other products.

This Wal-Mart product innovation follows on the heels of a similar consumer program they introduced some time ago. In this latter program, Wal-Mart introduced a $4 per subscription generic drug program for consumers. This drug program forced the entire retail drug industry to offer discount plans and it lowered the cost of drugs for consumers.

Wal-Mart is a discounter (See “Video #21: Definition of Price Leaders” on StrategyStreet.com). Will it succeed with this new business-oriented program? A discounter is likely to succeed if it can attract the largest customers in the market place. We call these Very Large customers. Wal-Mart has already attracted one of those very large customers in Caterpillar Company. Caterpillar has purchased drug coverage for 70M employees and their dependents through Wal-Mart. This customer has been so pleased with its savings in the drug benefit program that it has waived co-payments on generic prescriptions that its employees purchase from Wal-Mart. This, of course, makes the Wal-Mart program even more attractive to the employee because it is cheaper than any other alternative available.

The forecast? Costs down for businesses. Lower profits and growth for PBMs. (See the Symptom and Implication, "The industry leaders are losing share” on StrategyStreet.com.)