Supporters are heralding CVS Health's (NYSE:CVS) decision to create narrow pharmacy networks that penalize tobacco users as a brilliant move, but detractors think it may alienate customers. Both sides have valid arguments, but I think that CVS Health's decision leans toward the brilliant. Here's why.
First, a bit of background
CVS Health announced earlier this year that it would stop selling tobacco products in its retail stores and the company followed through on that promise in September.
The choice has been met both with support from antitobacco advocates who remain concerned by the number of preventable deaths caused by tobacco and by opposition from investors who worry over the impact of $2 billion in lost annual revenue and the risk of angering consumers.
In making its decision to halt sales of tobacco, CVS Health said that eliminating tobacco was in line the company's broader mission of improving consumer health. But recent news that CVS Health is creating new drug plans that charge higher co-pays for scripts filled at tobacco retailers suggests that the decision could also be based on feedback it was receiving from clients of its $76 billion pharmacy benefit business.
Here are three reasons why I like this move
1. Sure, eliminating tobacco sales at CVS Health stores means that the company is taking a short-term hit to its top line, but the decision also clears the way for CVS Health to deliver higher margins over the long haul. That's because high-value shelf space previously taken up by tobacco is being repurposed to house higher-margin products like private label health and beauty items.
Admittedly, margin improvement isn't going to make up for the impact of all the lost tobacco sales in the short term, so CVS Health needs other solutions that can drive retail script and front-of-store volume higher, too.
Creating tobacco-free pharmacy networks should do just that.
By making consumers pay an extra $15 fee to fill prescriptions at competitors like Walgreen (NASDAQ:WBA) and Rite Aid (NYSE:RAD), which still sell tobacco, CVS Health may be able to boost retail visits enough to offset some (and potentially all) of the tobacco revenue drop-off.
2. If CVS Health's PBM clients, which include insurers and large corporations that manage their own health insurance plans, opt-into these new plans, then CVS Health's retail market share should grow, giving the company additional margin-boosting purchasing power with drugmakers that could help its bottom line, too.
Such pricing power is critical in the wholesale and retail drug market, which operates on single-digit margin, and is a major reason behind Walgreen's acquisition of Alliance Boots and Rite Aid's shifting its drug purchasing to McKesson (NYSE:MCK) earlier this year.
3. In addition to providing a tailwind for CVS Health's retail business, reducing the number of scripts filled at tobacco retailers may also deliver value to CVS Health's PBM clients, further solidifying those important relationships.
Health payers like insurers are desperate to offset the soaring cost of prescription drugs; particularly, as drug utilization climbs due to ageing America and rising insurance membership. As a result, they're increasingly turning toward PBM's like CVS Health, Express Scripts (NASDAQ:ESRX), and Catamaran (UNKNOWN:CTRX.DL) to develop solutions that improve member health and reduce their costs of care.
Even if these new narrow networks only have a small impact in reducing tobacco use, they could still produce big savings to CVS Health's PBM clients.
According to a recent study by Brigham and Women's Hospital and Harvard Medical School, 6% of patients visiting CVS Health retail pharmacies to fill prescriptions for smoking-related diseases like COPD purchased cigarettes at the same time. Since tobacco use can lead to health complications in these patients, creating obstacles to access may result in fewer hospitalizations, which in turn could save CVS Health's PBM clients millions of dollars.
According to CVS Health, the decision to create plans for PBM clients that encourage shopping at tobacco-free stores was the results of requests from its PBM clients. That may indeed be the case given that Express Scripts recently announced that its clients have asked it to explore plans that would discourage filling prescriptions at tobacco and alcohol retailers, too.
Whether enough PBM clients embrace these new plans won't be known for a bit. But if they do, investors may soon forget about the lost tobacco sales and profits -- particularly if CVS Health is able to leverage foot traffic growth to boost demand for its in-store MinuteClinics and chronic disease healthcare programs.
Todd Campbell has no position in any stocks mentioned. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may or may not have positions in the companies mentioned. Todd owns Gundalow Advisors, LLC. Gundalow's clients do not have positions in the companies mentioned. The Motley Fool recommends Catamaran, CVS Health, Express Scripts, and McKesson. The Motley Fool owns shares of Catamaran and Express Scripts. 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.