10.20.17 | Forbes
By Steve Brozak
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It’s now a foregone conclusion that Amazon.com will enter the healthcare sector. Every day there is another article on how Amazon is planning to dominate some new corner of the American economy. One day Amazon is taking down Grainger and Home Depot. The next it’s single-handedly taking down not only FedEx, but also UPS and the United States Postal Service. No sector seems safe as Amazon sails its ship into new waters. But those expecting Amazon to cannon ball into healthcare may need to bide their time.
Two years ago I wrote in Forbes about how Amazon’s entry into healthcare could decimate CVS and Walgreens. I think it’s still possible, but not in the way the markets and media are anticipating today. Amazon’s entry into healthcare will not be sudden. It is likely to be similar to the acquisition of Whole Foods which developed over years as Amazon evolved its strategy in home grocery delivery, one part of the incredibly valuable consumables market. It was accomplished through trial, error and recognition that Amazon needed a bricks and mortar approach to the segment that led to the Whole Foods acquisition. Sudden and complete immersion into the healthcare system as it currently exists could taint the Amazon brand and will make the company vulnerable to regulatory risk. But there are segments of the healthcare market that offer an opportunity for Amazon’s unique capabilities, and there is evidence that Amazon has been making those slow and steady moves toward healthcare.
Becoming A PBM Could Be Amazon’s Healthcare Market Entry
Pharmacy Benefit Managers are the gate-keeping middlemen of the healthcare system. PBMs administer health plans for insurance companies and employers. They manage benefits and treatment costs for these organizations. The more organizations a PBM services, the greater number of patients (or lives, in insurance lingo) under its umbrella. With more lives comes more leverage when a PBM negotiates with pharmaceutical manufacturers for drug prices.
The three largest PBMs are Express Scripts, CVS and OptumRx, covering more than 80% of insured Americans. A PBM that manages tens of millions of lives has greater purchasing and negotiating power than a standalone company with 3,000 employees, or a pension plan with 20,000 lives, or even an independent insurance plan with just a few million lives. Among a slew of other services, PBMs primarily work with their clients to construct and administer a pharmacy benefit program, which is often referred to as a drug formulary. Formularies are just the lists of drugs that are approved or that have preferred pricing for the insurance company through a PBM’s negotiations with the drug’s maker. In exchange for placing its drug on formulary, a PBM receives a preferred price and a cash rebate from the drug’s manufacturer for every prescription it processes. Your insurance plan’s formulary is a major reason why your doctor prescribes you one drug company’s medicine over a competitor’s. Being the preferred drug is the goal. PBMs share a portion of the rebate it receives with their clients (the health plans) and patients receive the benefit of a drug at a preferred price. PBMs also collect fees for transactions and services it processes for its clients.
Target and Walmart learned that merely selling pharmacies in their bricks and mortar operations or through the mail doesn’t equal profits, although a case can be made that it certainly increases foot traffic and store loyalty. Margins are incredibly thin for the kinds of drugs they sell most routinely. In fact, Target sold its in-store pharmacy business to CVS, a pharmacy and a PBM, and Walmart has partnered with McKesson to source its drugs. Becoming a full service PBM would have allowed Target and Walmart to have greater control over margin, but it wasn’t in the cards for either company. While becoming a PBM could be the key to unlocking profits for Amazon, the current political and social environment is unfriendly toward PBMs and drug makers and comes with its own risks.
Despite this, a gamble in healthcare has to happen sooner rather than later. Amazon’s primary customer is between 30 and 45 years old, and that’s a demographic that will soon be looking to fill more and more prescriptions. And if you don’t think their customers’ life cycle milestones are part of retailers’ strategic plans, just look at the pace of acquisitions around baby startups just under a decade ago. Amazon bought diapers.com while Bed Bath & Beyond acquired Buy Buy Baby. Finding an algorithm that figures out when you’re going to have a child before you even think of having one yourself is the holy grail of E-commerce. The birth of a child is a significant milestone around which there is a burst of spending to capture. Likewise, as its consumers age and continue to change their habits through online shopping, healthcare has become the next frontier. Amazon has already made an entry and is setting prices for over the counter medications (OTC). On average, its OTC products, like Tylenol, are cheaper on its website than most bricks and mortar stores. There are several theories circulating around Amazon’s entry into healthcare. Here are my thoughts on three of the most common scenarios being discussed.
Scenario 1: Amazon Acquires Or Partners With A Large PBM
One of the more popular scenarios bandied about is that Amazon may acquire a large PBM player. This is unlikely for a few reasons. Foremost, while it would allow Amazon to quickly enter the healthcare market, integrating the processes and services from a large operation into Amazon would be complicated and chaotic. As the drug pricing debate continues in the mainstream, PBMs have been painted with a big target on their backs as more light is thrown on their opaque and very misunderstood segment of the healthcare system. Just this week, Senator Lamar Alexander (R-TN) wondered out loud why PBMs even need rebates, which is the lifeblood of the industry.
It will be very difficult to recreate the frustration-free consumer experience Amazon currently offers and replicate it through healthcare services as healthcare currently exists. Therefore Amazon will want to separate any healthcare services it offers from its main brand and ease into the business. You could argue that Amazon is already easing in by selling prescription drugs on their Japanese website, perhaps a test case for an American entry (supporting the case for Scenario 3). If you think Amazon can do no wrong, remember this is the company that thought it would be a good idea to emblazon Amazon.com on the back of its Fire Phone, a complete flop. Amazon can’t afford a flameout in healthcare, and making another transformative purchase that could easily eclipse the purchase of Whole Foods so soon, while entirely possible for a company the size of Amazon, would be wholly inadvisable.
As far as partnering goes, sure, Amazon could attempt to partner with a Prime Therapeutics or an Express Scripts. As others have pointed out, Amazon has a strong history of partnering with companies, leveraging its consumer reach and logistical magic to tap into and offer lifelines to companies like Circuit City and Toys R Us. But then what happened? The companies Amazon partners with tend to go out of business as Amazon upends the market.
Scenario 2: Amazon Re-engineers The Wheel With A Smaller PBM
It’s clear that Amazon needs to either re-engineer the PBM wheel or partner with a creative player who already is. While a partnership with a conventional middle market PBM will give Amazon a good entry point in healthcare, a better route would be to partner with an even smaller PBM to really learn the business, gain valuable insights on the industry and bring the PBM model into the 21st century. There are already reports that Amazon, with its 350,000 employees, is trying to administer its own health plan internally as its own PBM. While hiring executives from industry to construct its own virtual PBM is a good way for Amazon to start, it’s still just virtual. An even better path forward would be to acquire or partner with a smaller PBM that already manages millions of lives, self adjudicates (processes its own claims) and can easily manage an additional 350,000 Amazon employees. Through the smart acquisition of a creative PBM, Amazon would learn the business model and incorporate a PBM-like service into an expanding slate of healthcare programs and service offerings.
Scenario 3: Amazon Becomes A Bricks And Mortar Pharmacy In Order To Become A Mail Order Pharmacy
Amazon is well positioned to enter the mail order pharmacy business. Most mail order services are contracted out to a handful of other pharmacies that specialize in mail order delivery. For a while, insurance companies preferred their patients to enlist in a mail order pharmacy because the pricing was competitive compared to going to CVS or Rite Aid. Over the last several years that gap has narrowed. But mail delivery is what Amazon does very well, and combining a mail delivery strategy with a bricks and mortar strategy makes an incredible amount of sense for the company, especially now that it has acquired Whole Foods.
Before acquiring Whole Foods, it never made sense for Amazon to build or to acquire a network of independent pharmacies. Since none of the Whole Foods stores have a pharmacy, Amazon has an opportunity to establish in-store pharmacies that are powered by mail order fulfillment centers. A bricks and mortar strategy should be based around having an in store pharmacist fill as few prescriptions as possible. Rather, a regional prescription fulfillment center could fill and deliver the majority of prescriptions to both the store and to the patient’s doorstep. This is not unlike the current pharmacy model whereby local bricks and mortar pharmacists fill immediately needed prescriptions in the store, while chronically needed medications are filled and delivered to the store by a regional fulfillment center for monthly pickup by the patient. A model in which Amazon combines its mail delivery capabilities with its Whole Foods bricks and mortar would begin to draw two-way traffic from the stores and onto Amazon’s website. As patients sign up and manage their medications, they would create an essential link between the virtual and bricks and mortar Amazon. Shopping for eggs at Whole Foods isn’t going to compel me to go to Amazon.com no matter how many signs Whole Foods hangs in its stores to remind me that they’re now owned by Amazon. But managing my pick up/drop off of medications at my local Whole Foods through my Amazon health portal would draw me into both. Amazon seems to understand this and has already begun to blend its online business in Whole Foods by placing its innovative pick up/return locker system in Whole Foods lobbies.
Of course, while a current generation of Americans prefer to have the personal touch of interacting with and picking up their prescriptions, the trend will soon be to have most drugs delivered by mail. I have even evaluated companies that are working on fill-on-demand drug dispensing vending machines, which may also one day make their way into Whole Foods stores (let’s call them Locker 2.0). To date the one area of true weakness for mail order pharmacy services has been providing essential prescriptions immediately, say, on the day a patient is discharged from the hospital. That’s a weakness Amazon could easily topple with its tests of Prime Now, its same-day two-hour delivery service, another incremental step as Amazon inches toward the healthcare market.
Amazon’s customer base may be young, averaging 35 years old, but they are aging and in the midst of the child-rearing cycle, which requires frequent trips to the pharmacy. Amazon’s customers will need more prescriptions for themselves and for their children. Soon an entire generation will be even more used to buying things online. Right now Amazon has announced it is preparing to make two very big decisions public. The first is whether or not it will get into healthcare, to be announced, supposedly, sometime around Thanksgiving. The second is where it will locate its second world headquarters. If Amazon wants to capture as much of the purchasing a customer can do, it will need to mature with its consumers and formally enter into the healthcare market.
And as for my prediction for Amazon HQ2: It’s Boston.