McKesson Deal With Longs Prevents Self-Distribution In Northwest

McKesson is cutting its upcharge in Hawaii to Longs Drug Stores as part of a deal to prevent the chain from self-distributing to 20 Drug Emporium stores it will acquire in Washington and Oregon, Longs President Stephen Roath testified June 25 in the ongoing wholesaler merger antitrust suit in Washington, D.C.

Longs finalized an agreement July 6 to purchase Western Drug Distributors, which owns 18 Drug Emporium stores in Washington and two in Oregon.

"To keep us out of self-distribution for the stores in Washington and Oregon," McKesson made "a proposal to lower our upcharge, not only in the Oregon and Washington stores, but also for the Hawaii business," Roath testified. "So we ended up with a substantially improved cost of goods in a non-distributed area, without going to our own warehouse."

McKesson made the deal as a means of preserving its business with the Drug Emporium stores, which Longs could service from its own warehouse in Ontario, Calif. The stores, which had sales of $172 mil. in 1997, purchase all H&BA and pharmaceutical products from McKesson. Because of their higher average per store delivery, the Drug Emporium stores were paying McKesson a lower upcharge than Longs' California stores, which only use the wholesaler for slow-moving items.

In Hawaii, Longs will now have "a single upcharge for all items" as opposed to the previous cost plus zero on the 120 fastest moving items and cost plus .7 on all other products, Roath said. The effect in Hawaii will be that the upcharge "goes from cost plus to cost minus." Bergen also distributes in Hawaii and provides low-volume items to 10 of Longs' 32 Hawaii stores.

Longs will have 373 stores following the acquisition. The company plans to expand by three to five stores per year in the Northwest, the company reported. Western Drug Distributors President and CEO Jeff Meder will join Longs as a vice president to oversee the Pacific Northwest.

Roath testified that when Longs told McKesson in 1994 that it was considering supplying Hawaii either by air freight from its California warehouse or by building a warehouse in Hawaii, McKesson "agreed to lower our cost of goods on the top 120 items, which effectively lowered our cost of goods to a point where we could really no longer afford to consider either of the options."

"Essentially, it was going to increase [McKesson's] cost of distribution for all the remainder of product if we were to take... the cream off the top," the Longs exec said. "So they lowered their cost to us of the products we were buying in order to avoid our going into distribution."

During the trial, the wholesalers have argued that chains use self-warehousing to enforce price discipline on wholesalers ("The Pink Sheet" June 15, p. 3).

AmeriSource CEO David Yost testified June 29 that wholesalers can lose millions of dollars in sales when smaller chains are acquired by larger, self-warehousing chains.

Harco, for example, "was a great account, the kind of account everybody wants," Yost said. With $100 mil. in annual sales to 120 of Harco's stores, Harco was the "biggest account we had" for the Birmingham, Ala. distribution center.

When Rite Aid bought Harco, "our volume went from $100 mil. down to about" $12 mil., Yost said. "We lost $88 mil. worth of revenue because of Rite Aid," he claimed. "It went through Rite Aid's distribution center." Rite Aid acquired Harco in September ("The Pink Sheet" July 28, 1997, p. 23).

AmeriSource also sold approximately $100,000 per store per month to the 34-store Taylor Drug chain until Rite Aid bought it, after which the monthly volume dropped to about $9,000 per store, Yost said.

Yost added that AmeriSource was successful in having the Northeast food/drug combo Pathmark get out of pharmaceutical warehousing by focusing on return on committed capital. "We said, 'Your return on committed capital will increase significantly if you allow us to handle this.' And they agreed to that," Yost said.

The new joint venture Walsh Dohmen Southeast has also taken business from AmeriSource, Yost said ("The Pink Sheet" March 16, p. 23). Walsh Dohmen opened a distribution center in Birmingham "and they've taken $5 mil. or so a month from us," Yost said.