KICK THE HABIT

02.05.14

CVS Quits Tobacco to Become a Medical Giant

The company wants to get in the lucrative health-care business where firms are increasingly rewarded for reducing costs and improving outcomes. You can’t do either by selling a deadly product.

CVS made waves Wednesday morning when the ubiquitous chain announced its 7,600 stores would stop selling tobacco products as of October 1.

At first blush, it seems like a rare self-abnegating and idealistic move by a corporate giant. Cigarette sales are very important for convenience stores. People are addicted to the product, and when they come in for their fix, they tend to buy other stuff. CVS estimates that the move will reduce annual sales by $2 billion. Even for a company that racks up more than $122 billion in revenues annually, that’s a lot of cash.

While welcome, this is actually a hardheaded and highly practical move. Ultimately, CVS is ending the sale of cigarettes for the same reason it started selling them: to make money and be more profitable.

Here’s why.

First, while cigarettes are profitable, they are a declining market with an increasingly dim future. Thanks to years of educational efforts, the relentless toll of lung cancer, government regulations, cultural shifts, and new products like e-cigarettes, smoking is declining. Many states and cities have enacted bans on smoking in public places and in offices. Insurance companies—and your employer—would really prefer that you don’t smoke. Many government entities have done their best to make smoking prohibitively expensive. The federal cigarette tax is $1.01 per pack, but the combined New York City and New York State excise tax on cigarettes is a whopping $5.85. Smoking has become a very expensive and inconvenient habit.

CVS is ending the sale of cigarettes for the same reason it started selling them: to make money and be more profitable.

So it’s not surprising that Americans are quitting. In 2011, according to the Centers for Disease Control, 19 percent of adults smoked in 2011, down from 22.8 percent in 2001, and down from 37.4 percent in 1974. The trend is even more pronounced among young people. In 1999, 34.8 percent of students smoked. By 2011, that number had fallen to 18.1 percent.  Also, as this chart shows, consumption of cigarettes fell every year from 2000 to 2011. In 2011, some 293 billion cigarettes were sold in the U.S. That’s down from more than 400 billion a decade ago.

Cigarettes purchasers may represent $2 billion in revenues for CVS this year; it’s likely they’ll represent about $1 billion in ten years. So to a large degree, CVS is simply getting ahead of the consumer curve by removing the products from its shelves.

CVS is also getting ahead of an extremely important business curve. Yes, CVS is a massive operator of bricks-and-mortar stores that contain pharmacies and sell cosmetics and other items. But that’s not all CVS does. Not by a long shot. In fact, the corporate parent is known as CVS Caremark. Why? In 2007, CVS merged with Caremark RX, a huge pharmacy benefits manager (PBM). PMBs, as their name implies, manage the prescription drug components of Medicare and other public and private insurance programs. And that’s a huge and growing business.

CVS Caremark is a giant in this field. As the company proudly notes, “CVS Caremark’s retail pharmacy and pharmacy services businesses accounted for 22.8% of the nation’s total prescription revenues in 2012, according to the 2012-13 Economic Report on Retail, Mail and Specialty Pharmacies.”

CVS data by YCharts

The business is growing far more rapidly than CVS’s store-based businesses. In the third quarter of 2013, the Pharmacy Services Segment, with revenues of $19.5 billion, up 7.8 percent from the year before, accounted for 54 percent of the company’s total revenues. (The retail segment accounted for $16.3 billion, or 46 percent. But in the third quarter of 2010, by contrast, it was reversed: the retail segment accounted for 54 percent of revenues while the Pharmacy Services Segment accounted for only 46 percent.

That shift is accelerating. Given all the changes in the retailing and medical fields, CVS Caremark has decided it would rather be in the health-care delivery business than in the bricks-and-mortar retail and pharmacy business. And it is becoming a more sophisticated player in this field. In November, CVS Caremark shelled out $2.1 billion to buy Coram, a company that provides infusion therapies (dialysis, etc.) to patients in their homes and in its network of clinics. The company has built dozens of Minute Clinic primary-care outlets in its stores, staffed by nurses and physicians’ assistants. “As the delivery of health care evolves with an emphasis on better health outcomes, reducing chronic disease and controlling costs, CVS Caremark is playing an expanded role in providing care through our pharmacists and nurse practitioners,” CEO Larry Merlo noted in Wednesday’s press release.

But CVS doesn’t just want to treat the symptoms of medical woes. Insurers and medical organizations are seeking to make deals in which health-care providers are rewarded not simply for administering medicine but for reducing costs and improving health outcomes. As Sarah Kliff of the Washington Post reports the company believes “the decision to halt tobacco sales will make it easier to strike such deals, particularly those that include financial rewards for CVS if they can help patients stop smoking and reduce their medical bills.” After all, health insurers are probably not likely to hire a company to help people stop smoking if the same company is minting money by selling tobacco products.

Put another way, continuing to sell cigarettes—a declining business anyway—may make it more difficult for CVS to land more clients in a rapidly growing line of business. And the potential growth in those businesses could easily offset the loss of revenues from selling tobacco.

Which is why other retailers won’t necessarily mimic CVS’s move. Convenience store chains, or retailers that have smaller pharmacy operations, or giant retailers that aren’t in the health-care delivery business, don’t have the same incentive to remove cigarettes from their shelves.

CVS Caremark’s executives concluded that the long-term financial gains they might reap from cutting off cigarette sales outweigh the short-term gains they’d harvest by continuing to sell cigarettes. You could call it a bold strike for corporate social responsibility. Or you could call it capitalism.