First, the big bookstores. Then, major retailers. Are pharmacy chains the next to be steamrollered by Amazon (NASDAQ:AMZN)?
CNBC reported that the giant e-commerce company is exploring the possibility of expanding into the pharmacy market. According to the report, Amazon plans to hire a team and is in "deep discussion with industry experts." Could the stocks of major pharmacy retailers CVS Health (NYSE:CVS) and Walgreens Boots Alliance (NASDAQ:WBA) be in trouble in the not-too-distant future from a disruptive competitor with deep pockets?
A huge opportunity
It makes sense that Amazon would eye the pharmacy market. A whopping $425 billion was spent on prescription drugs in 2015 -- a record high. QuintilesIMS projects that prescription drug spending could reach $640 million by 2020.
The rapid rise of high-deductible health insurance plans is another key reason Amazon would be interested in the pharmacy market. According to a Kaiser Family Foundation survey, only 4% of covered workers in the U.S. had high-deductible plans in 2006. The number had soared to 29% by last year.
High deductibles cause Americans to pay much more attention to the costs of healthcare. And that presents an opportunity for Amazon. The company's current e-commerce strategy should enable Amazon to have lower-cost operations than brick-and-mortar pharmacies like CVS and Walgreens. Americans are already used to finding good deals on Amazon for other products. If the company offered prescription drugs also, there would likely be an immediate (and sizable) market.
Should CVS and Walgreens be worried?
CVS and Walgreens don't have reason to worry just yet, though. Amazon hasn't committed to moving forward into the pharmacy market at this point.
There are significantly more regulatory hurdles to clear with filling prescriptions than there are for selling books and other retail products. The Centers for Medicare and Medicaid Services (CMS) established standards for e-prescribing that must be followed. The U.S. Drug Enforcement Administration (DEA) has even more stringent requirements for electronically filling prescriptions for controlled substances, including many current pain medications on the market.
With Amazon's resources, though, regulatory hurdles shouldn't be a big factor in keeping the e-tailer from entering the pharmacy market. Actually, there don't appear to be any obstacles Amazon couldn't overcome if it chooses to move forward. The biggest prerequisite is acquiring the necessary industry expertise, and Amazon appears to already be taking steps to address this by recruiting a team of pharmacy industry experts.
Over the long run, though, CVS and Walgreens probably should be worried. Over 43% of CVS Health's total revenue in the first quarter of 2017 came from its retail/long-term care segment. More important, almost 79% of the company's gross profit stemmed from the segment. Nearly 85% of Walgreens Boots Alliance's first-quarter revenue and 93% of its adjusted operating income were generated by its U.S. and international retail pharmacies.
At least some of that revenue and earnings could be at risk if Amazon jumps into the pharmacy market. Of course, how successful Amazon might be depends on how much lower its prescription drug costs are compared to CVS and Walgreens. Unless costs are significantly lower, Americans might prefer to stay with their traditional pharmacies.
An especially vulnerable area
One area in which Amazon could potentially make significant inroads is in competing with mail-order pharmacies. CVS Health has 13 specialty mail-order pharmacies and four mail service dispensing pharmacies. Walgreens and Prime Therapeutics recently combined their mail-order pharmacy operations as part of a strategic alliance announced last year.
Here's the kicker with CVS Health's and Walgreens' mail-order pharmacy businesses, though: The operations are part of the two companies' pharmacy benefits management (PBM) units, and not their retail units. It's possible that Amazon could decide to not only compete in the retail prescription drug market, but also go after the PBM market.
Amazon hired Mark Lyons away from Premera Blue Cross earlier this year to build an internal PBM. It wouldn't be too huge of a stretch to expand into offering PBM services to external customers. Such a move wouldn't just affect CVS Health and Walgreens; large PBM Express Scripts could also be hurt if Amazon successfully launched a PBM.
I don't think CVS Health and Walgreens investors should be singing James Taylor's "Steamroller Blues" -- at least not yet. Even if Amazon decides to move into the pharmacy market, it could take a while for it to get its operations fully up to speed.
It's also possible Amazon's efforts could flop. Another e-commerce player, Drugstore.com, gave the online pharmacy business a shot, beginning operations when the dot-com craze of the late 90s was in full fever. Walgreens bought the small company in 2011 but shut it down last year.
However, I predict Amazon will enter the pharmacy market and will be very successful. That will hurt CVS Health and Walgreens. Whether or not Amazon will be, as James Taylor sang, a "hefty hunk of steaming junk" that rolls over the big pharmacy retailers remains to be seen.
Keith Speights owns shares of Express Scripts. The Motley Fool owns shares of and recommends Amazon. The Motley Fool owns shares of Express Scripts. The Motley Fool recommends CVS Health and Quintiles IMS Holdings. The Motley Fool has a disclosure policy.