Why CVS' Controversial Decision Marks a Bold Step in the Right Direction

By removing tobacco products from its stores, CVS does right by customers and shareholders alike.

Feb 6, 2014 at 6:15PM

Cvs Smoking

Source: CVS Caremark.

CVS Caremark (NYSE:CVS) announced Wednesday that its drugstores would remove cigarettes and other tobacco products from their shelves by Oct. 1. The news sparked much debate across the country and earned the company an incredible amount of press coverage.

The reason CVS' move ignited such a broad discussion -- a Google search yields nearly 2,000 articles covering a few days -- is twofold. First, customers generally expect little in the way of forward thinking, or even differentiation, for that matter, from the corner drugstore. Second, a debate about what businesses should and shouldn't sell attracts diverse and highly contested viewpoints. Here's why I believe CVS made the right long-term decision for its business model and, ultimately, all of its stakeholders.

Standing out on a crowded corner
The first point on differentiation is quite straightforward. Drugstore chains, in the eyes of the consumer, offer basically identical goods and services. Sure, there are a few products that differ from one to another, but for the most part, CVS, Rite Aid, and Walgreen have the same game plan: A boxy-looking store often perched on the same high-trafficked corner as a competitor delivers a generic product and experience.

As a result, the decision to pull into a CVS or Walgreen's is largely determined by the proximity of a store to a customer's walking or driving path. At least that's my experience; but I imagine others share a similar level of brand loyalty. In economic speak, customers like me show indifference to the goods being offered, and this results in a race-to-the-bottom pricing war, and meager industry profit margin of 3.4 percent. That's a war that CVS seemingly wants no part of.

Cvs In Texas

Source: Wikipedia

Instead, the pharmacy chain is steering down a divergent path from its peers, transforming from a retailer into a health-care provider. For example, CVS' pharmacy benefit manager business, known as Caremark, now contributes 60% of the company's $123 billion in annual revenue. The decision, then, to eliminate cigarettes was simple. As CVS CEO Larry Merlo stated, "We've come to the conclusion that cigarettes have no place in a setting where health care is being delivered." That makes sense, although one could easily argue that CVS is a few decades too late to this cause. But as they say, better late than never.

Taking the high road
The second point, however, extends beyond drugstore walls and hits on a more hot-button issue in the business world: whether large institutions, such as private corporations or government, should have a say in the choices we make as consumers.

This issue lies at the heart of the debate about Obamacare, former New York City Mayor Michael Bloomberg's foiled supersized soda ban, the presence of genetically modified organisms in our food supply, or even sexism in Super Bowl ads.

Truth be told, this is a convoluted discussion that can result in starkly opposed, yet valid, viewpoints. By no means do I intend to tackle every angle. In my opinion, however, CVS' move seems like a step in the right direction for one key reason: In this instance, the company made a bold decision to serve the best interests of its customers with absolutely no regulatory interference.

For starters, the potentially harmful consequences of smoking are no less unnerving today than they were 50 years ago, though my colleague John Maxfield admits we have potentially become "desensitized to the facts." He highlights 10 emphatic reasons why CVS decided to stop the sale of cigarettes. CVS, meanwhile, recognized the detrimental side effects of smoking in a press release: "Smoking is the leading cause of premature disease and death in the United States with more than 480,000 deaths annually."

As CEO Merlo elaborated, "Everyday patients and customers put their trust in us to help them on their path to better health." With that in mind, peddling cigarettes that lead to chronic health problems smacks in the face of what this emerging pharmaceutical services company is trying to achieve: a healthier outcome for customers.

Finding a win-win solution
Now, I'm not a CVS shareholder, but the move resonates with me as a customer and an investor, in general. I believe this produces a positive outcome because it involves no government oversight, and still allows potentially disgruntled consumers the opportunity to vote with their feet and buy cigarettes elsewhere. For CVS, alienating a fraction of its customer base was a risk that management was willing to take.

Furthermore, CVS' move could influence other businesses to take similar risks, all in the interest of providing greater outcomes for customers. Customers, after all, are stakeholders in a business, and their well-being (and survival, for that matter) is critical to the long-term success of a company like CVS.

The co-CEO of Whole Foods Market, John Mackey, is intimately familiar with this debate about the responsibility of businesses, and the needs and wants of customers. He described this responsibility of companies in the book he co-authored with Raj Sisodia, Conscious Capitalism: Liberating the Heroic Spirit of Business: "Businesses have to serve their customers and look out for their best interests. Often, this means that we need to educate them, not just respond to what they are asking of us."

Mackey elaborated in a highly relevant statement on retail: "Often, what customers desire to eat and what they actually need for their health are not the same things. ... A high percentage of people are addicted to substances that are fundamentally bad for them." The solution, from Mackey and Sisodia's perspective, is to educate, but not preach to, customers: "We have to satisfy...customers in terms of what they want in the moment, while steering them toward better choices over time."

This is exactly what CVS appears to be doing by taking some responsibility for the well-being of its customers. The decision could result in lower near-term sales -- the company estimates it will cost $2 billion in annual revenue -- but could also differentiate CVS from competitors, and lead to more satisfied stakeholders. After all, some major news outlets reacted positively to CVS' announcement, and one of its largest shareholders, the California pension plan CalPERS, voiced approval, as well.

A Fool's takeaway
In their book, Mackey and Sisodia said they believe more retail outlets will be forced to make decisions similar to CVS' discontinuation of tobacco products. Mackey pointed out that "customers increasingly look to Whole Foods Market to be their 'editors,' as we carefully examine and evaluate the products we sell." Only time will tell whether the drugstore competition will step up and make a similar announcement. For the time being, however, I think this was the right long-term move for CVS.

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Isaac Pino, CPA, has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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