Drug Stores and Proprietary Stores

SIC 5912

Industry report:

Establishments in this industry are engaged in the retail sale of prescription drugs, proprietary drugs, and nonprescription medicines and may also carry a number of related lines, such as cosmetics, toiletries, tobacco, and novelty merchandise. These stores are included on the basis of their usual trade designation rather than on the stricter interpretation of the commodities handled. This industry includes drug stores that also operate a soda fountain or lunch counter.

Industry Snapshot

In 2006 drug stores posted retail revenues of $189.3 billion, a 7.9 percent growth rate over 2005, according to the National Association of Chain Drug Stores (NACDS). Chain drug stores, which account for about 35 percent of the industry's 61,200 stores, took in $144.8 billion, or 76 percent of the income. Total prescription sales in all types of stores (traditional chain, mass-merchandise, supermarket, independent, and mail order) in 2006 were $249.8 billion, up 7.7 percent from $232 billion in 2005. The retail volume of prescription sales was 3.4 billion prescriptions in 2006, an increase of 4.3 percent from 3.28 billion in 2005.

The rapid growth in this industry toward the turn of the twenty-first century prompted powerful supermarket and mass-merchandise chains to enter traditional drug store markets, forcing the independent drug store industry to compete with these larger companies. In addition, the drug store industry faced narrowing profit margins due to the general push to reduce health-care costs in the United States; as a result, acquisitions and consolidation became prevalent. This combination of factors forced drug stores to concentrate on customer service, expand into niche markets, add products, form partnerships with suppliers and health-care providers, and automate operations for increased cost-efficiency.

Drug stores in the mid-2000s faced a future with potential for significant growth and unique challenges. The average age of the U.S. consumer is increasing rapidly as the Baby Boomer generation grows older. An aging population has increased health-care and prescription needs, thus providing a growing customer base for drug stores. However, paper-thin profit margins on prescription drugs, a shortage of pharmacists, and challenges from grocers and discounters may make the road ahead perilous.

In the mid-2000s, pain medication, particularly for headaches, was the top seller, accounting for nearly $955 million in sales. Nutritional supplements held the second spot, with $838.3 million in sales. Adult cold remedies sold $806.3 million in products, followed by women's hair coloring products with $596 million in sales, and facial products such as cleansers and lotions with $531 million in sales. The industry leaders were Walgreens, CVS, and Rite Aid, which held about two-thirds of the combined total market share.

Organization and Structure

As drug stores faced increasing competition from other retailers, chains and independents alike began to vary their store formats to differentiate themselves from competitors and strengthen their image as health-care providers. As a result, five main store formats emerged within the drug store industry: independents, chain drug stores, mass merchandisers, supermarkets, and mail order.

The drug store industry relied on four core product categories for a large percentage of total sales: prescriptions, OTC medications, toiletries, and cosmetics. Other categories commonly sold in drug stores included tobacco, consumables, stationery, and housewares. In general, however, drug stores responded to competition by strengthening core product areas in the late 1990s.

Background and Development

The drug store industry originated in the mid-1800s, when Americans began using "patent remedies" to treat illnesses. Some early pharmacists operated out of village apothecaries, where they purchased chemicals in bulk and mixed them on the premises to fill prescriptions. Following the Great Depression, pharmaceutical companies grew rapidly and opened sophisticated research facilities. The number of patents issued for drug products increased from fewer than 100 before 1940 to more than 4,000 by the 1950s. Medicines began to be marketed in final-dosage form under a manufacturer's brand name rather than in bulk as generic ingredients. As a result, the number of drug stores increased, while pharmacists adopted a service-oriented role in dispensing prescriptions.

The drug store industry more than doubled its sales volume during the 1990s, and several factors pointed toward continued growth into the next millennium. For example, the two demographic groups that used the greatest amount of medication were the fastest growing segments of the American population in the late 1990s and included adults over sixty-five and children under ten. In fact, the number of people sixty-five and older increased at twice the rate of the general population, while this age group received an average of twelve prescriptions per person compared to about five for the twenty-to-forty age group.

A total of 39,754 traditional drug stores existed in the United States in 1998. There were 19,110 traditional chain drug stores and 20,644 independent stores. The drug store industry as a whole posted a sales volume of $106.7 billion in 1998. These figures included not only prescriptions and OTC drugs sales but also general merchandise. Prescription sales and OTCs had total sales of $103 billion in 1998 and made up almost 61.5 percent of all sales in a traditional chain store. Chain drugstores accounted for 40 percent of those sales, while independents took 26 percent of the market. Mass merchandisers and supermarkets claimed 21 percent of the market, and mail order totaled 13 percent. The number of retail prescriptions increased from 2.0 billion in 1992 to 2.7 billion in 1998.

While this sector of the retail industry continued to see gains, consolidation swept through drug store chains towards the late 1990s, leaving a handful of strong players. CVS acquired Revco and Arbor Drug; Rite Aid purchased Thrifty Payless, Marco, and K&B; and J.C. Penney bought Eckerd Drug, merging it into its Thrift Drug operations. This merger activity was caused by increased competition to offer a variety of merchandise at low costs and the availability of convenience in terms of pharmacy outlets.

The drug store industry also benefited from the trend toward self-medication, and a healthier attitude among consumers in the late 1990s. Drug stores controlled 44 percent of the vitamin market in 1999, and the baby boom generation, which some experts called the most informed in history, often purchased OTC medications, vitamins, and herbal remedies to treat their own symptoms. In addition, the increased availability of generic substitutes for expensive, brand-name drugs expanded the overall market for pharmaceutical products.

The continuing success of OTC products prompted regulators to get involved in that segment. According to a March 1999 NACDS press release, "Vice President Al Gore announced a new federal regulation by the Food and Drug Administration designed to make OTC labeling easier for consumers to understand. The new regulation also requires OTC medicine manufacturers to revise product labeling to reflect the importance of consumers consulting with physicians and pharmacists on proper OTC usage." This action also pointed to the trend of enhanced consumer care in pharmacies and the involvement of pharmacists in consumer purchases. The NACDS reported that with "fewer hospitalizations leading to more and more procedures being performed on an out-patient basis, as well as the continued discovery of new and more complex drug therapy, there will be an increasing reliance on community pharmacy to educate and monitor patient therapy."

Another factor that continued to affect the drug store industry into 1999 was the growing emphasis on controlling U.S. health-care costs. In 1999 only 8 percent of health-care costs were pharmacy related. National health-care policies insured more Americans and expanded the market for drugs, but they also increased the pressure on drug stores to reduce costs and operate more efficiently.

While traditional chain and independent drug stores were dominant in the late 1990s, supermarkets, mass merchandisers, and warehouse clubs posted gains in prescription sales. Attracted to the industry's growth, competition from these stores presented significant challenges to drug stores and led to a shakeup among independents and regional chains, evident by the merging or buying out of thirty-five chains since the early 1990s. Supermarkets continued to hold an important advantage over drug stores in consumer exposure, since the average person visited a supermarket 2.2 times per week compared to once per month for a drug store. Many supermarket chains began competing aggressively for sales of HBAs by cutting prices, increasing advertising, and emphasizing the convenience of one-stop shopping. In addition, supermarket chains opened in-store pharmacies, which they felt increased store traffic and provided a community service. Mass merchandisers such as Wal-Mart, Target, and Kmart entered traditional drug store categories, supported by their superior distribution networks and technology, and claimed a 10 percent share of prescriptions in 1998.

Drug stores also faced a growing challenge to their profitability as third-party payment accounted for a larger percentage of prescription sales in the late 1990s. Third parties included health maintenance organizations (HMOs), preferred provider organizations (PPOs), unions, government programs (Medicare and Medicaid), and other systems that covered costs by prearranged agreement with health-care providers. Prescriptions represented the largest out-of-pocket expense for consumers, so third-party payment increased substantially as part of the drive to control health-care costs. This trend affected drug store profitability since third parties typically applied a discount of 20 percent to the average wholesale price of a drug, plus allowed dispensing fees, which covered administrative and labor costs of only $3.00 per prescription as opposed to the actual cost of $4.50. Drug stores struggled with the low margin sales and costly paperwork but appreciated the large prescription volume that third-party systems could provide.

Consumer demands for lower health-care costs also affected drug stores' ability to raise prices. In the past, prescription prices generally increased at twice the rate of the Consumer Price Index, and drug stores turned this trend to their advantage. Drug stores would often forward-buy inventory of pharmaceutical products at low prices and usually passed along price increases to consumers with little negative effect on sales. In 1998 brand-name prescription costs increased 8 percent while generic increased by 2 percent. The average cost for a prescription was $34.43 in 1998, with 74 percent of cost going to the manufacturer, 3 percent to the wholesaler, and 23 percent to the retailer. Stores also had to remain price competitive in HBAs. Many stores focused on a policy of "everyday low pricing" and beefed up advertising to lure customers.

Another challenge to the drug store industry was the advent of Internet drug stores. While Internet sales represented only 1 percent of industry sales in the late 1990s, that number was forecast to grow along with other retail sectors. These sites, such as DrugEmporium.com, offered prescription and nonprescription drugs, cosmetics, and health and beauty aids. Many offered e-mail access to pharmacists as well. Large drug chains followed suit, and customers could refill prescriptions on store Web sites such as CVS.com. This industry, however, was expected to see advantages from the Internet as well. In a Drug Store News editorial, Anthony Cuti, chairman and CEO of Duane Reade, stated that "the bottom line is that personal medical consultations will grow more toward the individual pharmacist and less toward impersonal, less responsive communication vehicles such as the Internet. The Internet, however, will be a great provider of increased general health information that will probably promote a greater number of visits to both physicians and pharmacists to interpret and apply the technical information retrieved from the Internet."

Grocery stores and discounters were eagerly entering the market for prescriptions and other health-care products. In 2002 the mega-discounter Wal-Mart operated 2,977 pharmacies. In addition, at least five supermarket chains reported pharmacy revenues over $1 billion. Traditional drug stores were starting to give ground to grocers and discounters. According to the NADCS, prescription volume growth slowed for drug stores, increasing by 5.8 percent in 2001, compared to 10.4 percent in 2000. At the same time, discounters and grocers increased prescription counts in 2001 by 5.9 and 7.3 percent, respectively.

Current Conditions

The American population is aging. Those fifty-year-old or older group was expected to surpass 95 million by 2010, compared to 75 million in 2002. In the mid-2000s, people aged sixty-five and over totaled approximately 35 million, or 12.6 percent of the U.S. population. By 2030 that number was expected to double, and by 2050 almost 90 million Americans were projected to be 65 and older, representing 30 percent of the U.S. population. The significant increase in older consumers meant a rapidly growing customer base for drug stores. According to NACDS, a projected 3.4 billion prescriptions were filled in 2006 in retail drug stores, an increase of 4.3 percent over 2005. These sales amounted to $249.8 billion, up 7.7 percent from 2005.

Retail revenues for drug stores in 2006 were $189.3 billion, a growth rate of 7.9 percent over 2005, according to NACDS. Chain drug stores accounted for about 35 percent of the industry's 61,200 stores and took in $144.8 billion, or 76 percent of the income.

Increased prescription sales have not left drug stores unchallenged, however, as reimbursement by third-party prescription administrators, which came to dominate the market, were cut drastically. The biggest hit came in Medicaid-funded prescriptions, in which the profit margin might be as low as 2 percent. "The demand is going up and up, and we're keeping pace and delivering services, but we keep on getting squeezed because no one wants to pay for the service," Crystal Wright of the NACDS told Supermarket News. One bright spot for pharmacy departments was the impending end to patent protection by a number of widely used drugs. Once the patent protection period expires, generic brands are available, which usually provide a higher profit margin.

Other problems for drug stores were related to drugs being illegally imported from Canada via mail order. In addition, counterfeit drugs created by sophisticated production labs were circulating sham pharmaceuticals on the market. In 2004 digital tracking systems and other such protective measures were widely promoted in the industry.

To compete with mass merchants and grocery chains, drug stores marketed themselves as uniquely equipped to service the "quick-trip" shoppers. According to Chain Drug Review, the average trip to a drug store takes ten minutes, or eight minutes if the customer is not picking up a prescription. Drug stores are also adding food items such as milk, frozen foods, and other staples to bring in time-pressed women and older shoppers who buy for smaller households and may not need to stock up at the grocery store as often but may run low on basic food items. A study from the National Association of Chain Drug Stores, reported by Chain Drug Review in 2003, found that more than 60 percent of shoppers would go to drug stores more often if the beverage and food sections were better laid out and stocked.

Industry Leaders

Walgreens, the number-one drug chain in overall revenue, operated almost 6,000 stores in 48 states and Puerto Rico and posted sales of $53.76 billion in 2007. The chain filled 583 million prescriptions that year, or 16.7 percent of the U.S. retail market. The company expanded into new areas, both geographically and with products. In addition to adding photo-finishing departments to its stores, the company started its own pharmacy benefit management firm, which is actually run through the chain's mail order business, Healthcare Plus. The store offered an online pharmacy and had 226,000 employees in 2007.

CVS Corp., the number-two drug chain, reported sales of $43.8 billion in 2006. The company grew with its purchases of Revco, Arbor, and Soma, an online pharmacy, and had more than 6,200 stores in operation in 2006. Its subsidiary, PharmaCare Management Services, provided managed care drug programs to its customers. CVS had more than 176,000 employees in 2004.

RiteAid Corp., the number-three drug chain, had sales of $17.5 billion in 2007. With the acquisition of the Brooks and Eckerd chains, the company added 1,800 stores in 2007 and increased its operations to more than 5,000 stores in 28 states across the United States.

Workforce

Pharmacies and drug stores employed 771,000 people in 2004, according to the U.S. Census Bureau, reflecting an increase over the 680,000 employed in 2000. The industry's total payroll in 2004 was $18.4 billion.

While chain drug stores employed almost 96,000 pharmacists in 2001, the major concern for this industry was the shortage of qualified pharmacists. In 2003 there were 5,500 jobs available in this sector. Of 96,000 employed pharmacists, 80,000 worked full time. More than half of those full-time pharmacists were men. According to the U.S. Department of Labor, Bureau of Labor Statistics, the mean annual salary for a pharmacist in 2001 was $73,060. A pharmacy technician earned a mean annual salary of $20,530.

Research and Technology

Faced with managed care and an aging population with increasing needs for prescriptions, drug stores turned to technology to increase productivity. According to Drug Store News, "Drug chains are turning increasingly to pharmacy technology to automate the workflow, speed the filing process, and take the guesswork out of nearly every aspect of prescription dispensing. In the process, they have poured tens of millions of dollars into high-speed pill and tablet counters, new prescription tracking software, robotic devices, work-station terminals and interactive voice response systems (IVR) for phone-in refills."

IVRs became increasingly popular in the late 1990s. With the growing number of prescriptions, these systems allowed the pharmacy staff to concentrate on filling prescriptions and talking with in-store customers instead of taking orders over the phone. CVS, for example, implemented these systems throughout the company's chain stores.

Other new technologies emerging included AutoScript III, which integrated robotics, labeling, and pill counting into a touch-screen system; QuickScript System, used for automating the entire filling process including labeling, filling, and capping, and streamlined the paperwork and inventory process to allow ninety prescriptions to be filled per hour; and RX-90 by Condor Corp., which simplified the inventory process. In addition to these technological advances, many stores instituted a satellite network to allow prescriptions to be filled anywhere in the United States. Drug store chains also began using electronic data interchange (EDI) systems to share information with suppliers. Although relationships between drug stores and suppliers were traditionally somewhat adversarial, intensified competition in the industry led to the formation of alliances.

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