Amid a consolidating market, a few Rx giants emerge

The strongest have survived. They’ve also gotten a lot bigger and more powerful.

Years of take-no-prisoners competition and withering profit margins at the pharmacy counter have severely winnowed the retail pharmacy playing field, and the attrition rate shows no sign of leveling off. The result has been the emergence of a handful of pharmacy giants with national reach and growing leverage in purchasing and managed care contracts—and increasing prescription market share for both drug store and mass merchandise chains.

The consolidation has been dramatic. A few powerhouse retailers have emerged as dominant players. Between them, the industry’s top two chains, Walgreen Co. and CVS Corp., control more than 30 percent of the nation’s retail pharmacy business, with combined prescription sales of more than $60 billion. Throw the No. 3, 4 and 5 players into the market-share equation—Rite Aid, Wal-Mart Stores and Kroger Co.—and together those five chains account for nearly half the nation’s retail pharmacy market.

The list of proud regional dynasties that have succumbed to the ruthless competition and/or merged with their larger counterparts could fill an industry directory, and that list continues to grow every year as the biggest retail operators wield ever-more-powerful economies of scale and outside threats like Medicaid reimbursement cuts add to the attrition rate.

Independent drug store operators are faring even worse in this new era of consolidation. After several years in which the independent pharmacy community staged a rebound, the past year has seen a major retreat in numbers.

More than 1,100 independently owned community pharmacies were sold or closed in 2006, according to Charlie Sewell, senior vice president of government affairs for the National Community Pharmacists Association. Citing a new report on independents from NCPA, he laid much of the blame on reimbursement foot-dragging by the prescription drug plans administering Medicare Part D drug benefits since the Part D program rolled out in January 2006.

“We’re losing an average of three independent pharmacies a day,” Sewell noted.

According to NCPA, the average net margin for owner-operated drug stores dropped 30 percent last year, from 3.7 percent to 2.6 percent. Those declines reverse a long period in which independent pharmacy appeared to regain its footing, with the industry rebounding to more than 24,000 stores nationwide in 2005. Since then, the number of indies has fallen to 23,000 or less, Sewell said.

“Both the independents and food stores are losing market share,” reported Meredith Adler, retail analyst for Lehman Brothers Equity Research. “We believe the independents will continue to lose share in the future as the costs and liquidity pressures caused by the shift of dual-eligibles to Medicare, combined with cuts to Medicaid, put great pressure on their profitability. This is likely to cause many to sell out to larger retailers.”

Hammered by the impact of mail-order competition, ever-tighter third-party reimbursements, federal cost-cutting initiatives and rising operating costs for pharmacists’ salaries, real estate and technology, pharmacy profitability remains on the endangered species list. As reported by Fortune and the National Association of Chain Drug Stores, net profit margins for food and drug stores average about 1.3 percent, compared with a Fortune 500 median margin of 5.2 percent.

Nevertheless, programs like Medicare Part D also have generated millions of new prescriptions for the nation’s pharmacies, as many of the nation’s roughly 44 million Medicare beneficiaries have signed up for benefits.

Prescriptions dispensed through Part D accounted for 17 percent of retail prescriptions by the end of 2006, according to IMS Health.