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This article was originally published in The Tan Sheet

Executive Summary

DRUG STORE CHAINS MUST "REVITALIZE" FRONT-END BUSINESS of their stores as a way to remain competitive in the face of shrinking profit margins in the pharmacy area, outgoing National Association of Chain Drug Stores Chairman Harvey Rosenthal said in his April 18 "State of the Industry" address at the group's annual meeting in Palm Beach, Fla. Rosenthal observed that the "best antidote to declining pharmacy profitability is a healthy front end." Rosenthal, president and CEO of CVS, recommended that the chain drug stores industry "must sharpen and clarify what we stand for." He explained that pharmacies "must say 'health care' [and] our front stores must say 'value' -- not just good prices, but that combination of selection, service, reliability, consistency, and merchandising excitement that add up to a value statement that makes the front end as much of a destination as the pharmacy." In an appeal to suppliers to recognize the reach of the industry as well as the specialized needs of the drug chains, Rosenthal pointed out that chain drug stores "have uniquely different needs from 60,000 sq. ft. food stores, 90,000 sq. ft. warehouse clubs and 120,000 sq. ft. mass merchandisers." He added: "We may not sell by the pallet, but with 22,000 [stores], those ones and twos add up quickly." Rosenthal singled out OTCs as one of the front end areas of "universal importance" in the chain drug store industry. Acknowledging that "different chains approach the [front-end store] business with different areas of emphasis," Rosenthal pointed to "health and beauty aids with an emphasis on OTC categories" as among the "universally important" areas for drug chains given the new environment for prescription drugs. He also suggested that "the more therapeutic-type categories in the skin care area" represent another key chain store market as well as photos and cosmetics. Three other areas that the industry must focus on, Rosenthal said, are institutional customers, new technology and consumer expectations. On the technology front, Rosenthal said the industry "must use technology to take costs out of our operations because lower gross margins are here to stay, and we can't maintain our profitability without ratcheting down our costs." Chain drug stores' profitability is being squeezed by third party and managed care programs that increasingly are bidding for business -- and not just among traditional retail pharmacies, Rosenthal indicated. "We are all threatened and challenged by seriously eroding pharmacy margins, as third party and managed care programs become the predominant way prescriptions are written and dispensed and paid for," Rosenthal pointed out. He predicted that the national health care reform initiatives now being formulated in Washington "are only going to exacerbate these issues." For these institutional customers, he suggested that the industry needs "to learn how to satisfy . . . [their] needs as well as we satisfy the consumer today." Third party contracts, Rosenthal explained, "tremendously affect our business because [they can] swing large numbers of prescription [customers] and the ancillary business that goes with [them] either toward our stores or away from our stores." He observed that "it is a very different business from traditional retailing where you run a store or you own a store and you try to make [that] store desirable. [Third party] is a business to business relationship -- we're the supplier and the institution is the corporate customer. That suggests some different skills [and] it suggests some different organizations within the retail company itself." The new NACDS chairman, Thrift Drug President and CEO Robert Hannan, said that the time when industry built stores and "waited for customers to come and pay full price" is past. He predicted that the third party share of the prescription drug business will reach 75% "in the near future." He added that industry must do a better job of communicating its message that pharmacy services represent a value portion of health care, and he emphasized that suppliers and retailers "can't afford not to be on the same page." Hannan recommended that for both sides it is "time to throw out standard operating procedure" in order to stay ahead of the changes that are affecting retail pharmacy.

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