A pharmacy benefit manager (
PBM
) negotiates prices with the drug manufacturers and provides
prescription medicines at discounted prices. Costco (
COST
) recently started its own PBM program known as Costco Health
Solutions, which fills out prescriptions for small and midsize
business customers and their employees.
With this program, Costco advances into a new market of handling
drug plans, which is already dominated by players such as CVS
Caremark (
CVS
) and Express Scripts Holding Co. The primary strategy behind this
move is to improve the store traffic and generate higher sales. The
retailer is also making a bet that its the employees of its
business accounts might end up becoming Costco members.
See our complete analysis for Costco
On Its Own, Pharmacy May Not Help Costco
Costco's gross margins are already razor thin due to its
business structure and pushing into a low-margin pharmacy business
will not help them. Moreover, the retailer has to compete with big
players such as CVS Caremark and Express Scripts Holding Co. Costco
is less likely to have a competitive advantage because the retailer
is not known for its pharmacy business and is new to the
market.
Even if Costco gets good results from its PBM program, the
impact on the retailer will be minimal due to low revenue share of
pharmacies. Pharmacy is one of the seven subcategories of Costco's
ancillary businesses, which constitute only 18% of overall
revenues. Assuming even contribution from all the subcategories, we
estimate pharmacy revenues to be around 2.5% of Costco's overall
revenues. Quite clearly, pharmacy alone does not make a material
difference to Costco's sales.
However, Costco Can Target $1.5-$4.5 billion In
Additional Revenues With More Store Traffic
Costco's PBM program focuses on signing contracts with small and
medium-sized businesses located in its vicinity. The retailer will
provide discounted prescription medicines to their employees
through its in-store pharmacies and 64,000 independent pharmacies.
Hence, the employees of these businesses may become familiar with
the cost benefits of shopping at Costco and might end up becoming
its members. The customers may be reluctant to sign up for Costco's
membership as they look to tackle the tough economic
environment.
As of fiscal 2012, the retailer had around 10 million business
members. Assuming that about 10%-15% of the existing business
members joining this program, there will be around 1 to 1.5 million
businesses taking advantage of Costco Health Solutions. If we
further assume that a contract with each of these businesses
results in 1 to 2 employees becoming Costco's members, we are
looking at close to 1 to 3 million additional members. Given that
Costco earns $1,500 per member annually in revenues, there is an
opportunity to grow total revenues by roughly $1.5 to $4.5 billion
if its PBM takes off.
Our price estimate for Costco stands at $111
, implying a premium of about 10% to the market price.
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