Walgreens, Mass Closures, and the Power of Incentives

Kimberlee Josephson 11/6/2024CommentaryHeadlines about Walgreens closing 1200 stores over the next few years are making waves across the United States as anxious store managers wonder if their location will be next. According to an earnings release report from Illinois-based Walgreens Boots Alliance , the firm plans to finalize a "significant multiyear footprint optimization program." A program that seems sorely needed given recent reports of a $3 billion loss . In September, Walgreens stock hit a multi-decade low and "weak margins, persistent profitability issues, and a heavy debt load" were all noted as major problems for the firm.Despite Walgreens being ranked as one of America's most trusted brands , with a rich history dating back to 1901 , 500 stores are slated to shut their doors in 2025 with more closures to come in the years following. And Walgreens isn't the only pharmacy facing troubles, Rite Aid filed for bankruptcy in October 2023. So, with this in mind, let's take a high-level look at what is ailing the pharmacy sector and why we all should be mindful of the meaning behind such store closures.

It's the Economy Stupid

Walgreens is more than a pharmacy; it's a retail store where you can grab shampoo, snacks, milk, and magazines. Walgreens doesn't compete on price with the likes of Walmart and Costco, who leverage scale economies, rather it relies on consumers who are willing to pay more for local convenience. However, thanks to door-to-door and same-day deliveries, the convenience aspect of small neighborhood retailers is less valuable today and, in the present inflationary environment , consumers have become increasingly price sensitive . Even when waiting for a prescription to be filled, consumers would rather kill time by shopping online via their phones instead of browsing store aisles.In-store sales matter for Walgreens since it enables opportunities for cross-subsidization, whereas profits from purchased consumer products can be re-allocated toward overall operational expenses. Cross-subsidization is a common practice in the business realm—for instance, airlines subsidize the costs of economy seating with the price of first-class tickets. And it is well known that pharmaceutical manufacturers rely heavily on the success of one drug to supplement the costs of development and the trials of other drugs.In short, Walgreens can't shoulder inflationary operational costs without in-store sales ; and consumers can't shoulder the convenience premium Walgreens charges in the current economic environment . The consumer shopping component , however, is only one of several factors giving Walgreens trouble.

Incentives Matter–Always

Over the past few years, enrollment in pharmacy schools has gone down while pressures for the profession have gone up—particularly during the pandemic. Pharmacists work long hours, sometimes alone, and can face unhappy and unwell customers. But, the real issue pharmacists have been facing is the dwindling of drug reimbursement rates thanks to the rise in power of Pharmacy Benefit Managers (PBMs).

PBMs got their start in the 1960s when both health benefit plans and prescription drug options increased. Rather than patients paying for a prescription and then submitting a claim to their insurer or employer to process, PBMs stepped in to handle this administrative matter. But, as time went on, PBMs expanded their role beyond processing claims and facilitating reimbursements to determining what drugs should even be considered for coverage and reimbursement on health plans.

According to the National Association of Insurance Commissioners (NAIC):"PBMs work in conjunction with drug manufacturers, wholesalers, pharmacies, and health insurance providers but play no direct role in the physical distribution of prescription drugs, only handling negotiations and payments within the supply chain. When a new drug is available, the manufacturer negotiates with wholesalers who then sell and distribute drugs to pharmacies. PBMs negotiate agreements with drug manufacturers on behalf of insurers and are paid rebates by drug manufacturers."The incentives for PBMs, in addition to drug manufacturers, are to have higher priced drugs on healthcare plans since the higher the price, the bigger the rebate for the PBM. And, given that patients will go with whatever drug is covered by their health plan, drug pricing can (and has) run amok .

The Medicare Market Mess

Although PBMs have been around since the sixties, it wasn't until the 2000s that prescription prices started skyrocketing . And, as with many things, government involvement is what inflated this mess. In 2003 , President George W. Bush signed the Medicare Prescription Drug, Improvement, and Modernization Act which applied Medicare coverage to outpatient prescriptions that were previously not covered. The passing of Medicare Part D, in 2006, resulted in a substantial captive market made up of Medicare enrollees in need of prescriptions to be processed through Part D plans. And since PBMs were tasked with not only processing claims but also the negotiation of drug prices on those plans, drug companies sought the favor of PBMs, not patients, in order to capitalize on Medicare payments. So, as the 2000s progressed, so too did the prescription drug market and prescription prices .One of Walgreens competitors, CVS, had the foresight to adapt to the change in market dynamics and acquired Caremark , a PBM, in 2007. Today, CVS is in a better position (albeit not stellar ) when compared to Walgreens because of its PBM rebates as well as its pursuits to play a part in drug manufacturing. CVS announced in 2023 its new subsidiary Cordavis as a form of vertical integration for commercializing select medications as CVS prepares to contend with alternative pharmaceutical services that aim to counter drug price hikes—notably, Mark Cuban's Cost Plus drug program.For those without a CVS nearby or are unaware or unable to take advantage of alternative out-of-pocket pharmacies forgoing PBMs, the closing of Rite Aid and Walgreens stores is no trifling matter.

Pharmacy Deserts and Future Prospects

While it is reported that close to a majority of Americans live within five miles of a pharmacy, there are legitimate fears that pharmacy deserts will become more prevalent . Pharmacy deserts refer to areas where access to pharmaceutical care is limited or lacking; and for those in need of such services, convenience is key. It may not sound like a problem if a pharmacy is a 15-minute drive away, but it is for those who need to have a prescription urgently or consistently filled. Distance is also particularly troublesome for elderly patients or those with limited means for transportation.Indeed, an inconvenient location may result in some patients forgoing treatment, which could result in bigger medical problems in the future. And while there are more options now for online fulfillment and shipment , the human element is an aspect that should not be easily dismissed. The pill package in your mailbox won't be asking how you are doing or be able to visibly see you and ensure you're on track with taking your meds. Medication deliveries can't readily respond to your questions, forewarn you of newly discovered potential side-effects, or remind you to adhere to certain instructions like taking your dosage with food. Moreover, many pharmacies provide on-site advice, vaccination services, and select clinical tests which can eliminate the need for making appointments with your primary care physician for non-urgent matters.

America's population is aging at a high rate and pharmacies closing at a time when the volume of those needing medication moves upward is not a good situation to be in. Especially when some communities do rely on Walgreens or Rite Aid as their local convenience store. But, when one store closes, sometimes another one opens.

In fact, another namesake American brand , Dollar General (DG), has taken over a few vacant pharmacy locations and revamped some to become DG Markets . DG Markets provide fresh produce in addition to everyday consumer goods and so this could be a welcomed change in some areas. A few years ago, DG announced its mission to fight food insecurity by targeting locations prone to food desert status (areas with limited access to nutritious food options) and in doing so, DG may be able to assist with triaging the rise in pharmacy deserts. And although DG doesn't currently offer prescriptions, they've recently expanded their health and wellness offerings with more over-the-counter medications.All in all it is easy to see that there is no quick fix to the current conundrum for failing pharmacies. Companies with strong bottom lines can usually get by during seasons of underperformance by reallocating resources and engaging in cross-subsidization but, for Walgreens, this is not the case. Dwindling drug reimbursement rates, worker shortages, and inflationary operational expenses have taken its toll on this American brand. And while store closures may be a real burden for some communities, it is also worth noting that telehealth services and direct-to-consumer drug options are expanding and increased market pressures for prescription access may hurry along such programs.Persistent problems tend to incentivize the ingenuity of entrepreneurs in a market economy and so, to keep moving forward, the pharmaceutical sector should invest in what's working and encourage innovations and experimentation. Prices are best kept in check when production, distribution, and consumption are determined by voluntary exchange, which means it would be best to block any further government involvement and rescind programs that have increased drug costs . To be sure, what the healthcare market needs is more creativity and flexibility, and less bureaucratic meddling. Interventionist plans can never deliver that which entrepreneurship can.Walgreens may be operating under unprecedented pressures, both market and regulatory, but store closures are still a far cry from a death knell. The hard choices and strategic decisions for dissolution being made in the C-suite are par for the course in a changing business environment. Walgreens' shift of resources to regain market cap means they're listening to customers and serving investors. Agile brands and leaders are capable of handling dynamic market shifts, unlike central planners and government programs which don't know when to quit .From the American Institute for Economic Research (AIER)Views expressed in this are opinions of the author and do not necessarily reflect the views of The Epoch Times.