Why Amazon's Pharmacy Idea Just Might Work

A vial of pills and a pile of coins on either side of a scale.

Recently, Amazon (NASDAQ: AMZN) made waves when CNBC reported it had hired a team to look seriously at developing a prescription drug delivery service . In April, the company hired Mark Lyons, former director at Premara Blue Cross, to potentially create an internal Amazon pharmacy benefits manager (PBM) for the company's 128,000 employees. That could potentially lead to a broader PBM strategy to take on retailers CVS Health (NYSE: CVS) and Walgreens Boots Alliance (NASDAQ: WBA) , as well as PBMs such as Express Scripts (NASDAQ: ESRX) .

Some analysts such as Mizuho's Ann Hynes are skeptical, however, citing "major infrastructure, payer and regulatory hurdles." Among these hurdles are safety regulations for handling and distributing drugs by mail, a lack of retail footprint, and the long-term contracts and relationships that the current players have developed.

I happen to think that Amazon has a fair shot at cracking the market...eventually. Right now, the company has an eye toward an internal PBM, but I believe it could develop a successful larger strategy. Here are a few reasons why.

Not Amazon's first rodeo

First, Amazon has tried out prescription drug e-commerce before. The company acquired a large 46% minority stake in '90s tech start-up, with Jeff Bezos joining the board. However, Amazon's stake was reduced over time to just 12%. Walgreens eventually bought for $429 million in 2011. Perhaps Bezos won in the end, as Walgreens shut the site down in 2016, claiming it was part of an initiative to cut costs and promote

In other words, Bezos has had years of experience in this field, and already has a "failure" under his belt -- if one could call it that. The fact that Amazon is now scaling up its own PBM may indicate the company sees a new opportunity in the current landscape.

Rising costs

And the landscape has certainly changed. At the time of Amazon's max investment in in 2002, the prescription drug market was $102 billion. Now it's over $300 billion thanks to inflation and the aging population.

Current pharmacy benefit managers and pharmacies have also come under scrutiny for their failure to stem drug costs. Under the Bush administration, retail pharmacies were allowed to buy pharmacy benefit managers, and visa versa. PBMs are distributors and pharmacies like Walgreens (which owns several PBMs) and CVS (which owns PBM giant Caremark) are retailers, so ownership of one by another deters negotiation, and can potentially limit access.

The top three PBMs made up 78% of the market, or 180 million Americans, as of mid-2016. This means these companies can use the market concentration to keep drug prices high.

At this year's Berkshire Hathaway (NYSE: BRK-A) shareholders meeting, Charlie Munger lamented the complexity and waste in the healthcare system today.

In this backdrop, more and more Americans are also now in higher-deductible plans, which means they will have to bear these greater costs.

Moreover, the largest PBMs, such as CVS Caremark and Express Scripts, have come under criticism for their accounting practices, which critics believe may actually be more than double the 4%-7% margin they report.

If margins are actually more like 10%-15%, that gives a player an opportunity to undercut them. Of course, it would be a massive undertaking. A potential challenger would need to make the massive financial and time investments to develop the business and settle for single-digit margins, all while taking on large, entrenched players. So basically, only Amazon could conceivably do it.

New capabilities

Amazon is also in a much different place now than it was in 2011. For one, it has a legitimate cash cow, Amazon Web Services , which gives it the company billions of dollars to put to work. The company has also greatly expanded its procurement, transportation, and delivery capabilities, building warehouses and even leasing 40 planes. Prime Now currently offers same-day delivery on over 25,000 items. That could make a difference for prescription drugs, where patients often need their medication as soon as possible.

Moreover, Amazon has also reportedly made plans to roll out brick-and-mortar stores, and looks to be unveiling its Amazon Go cashier-less grocery stores in the U.K. very soon. A prescription drug service could potentially tie up with these two initiatives. Other advances in artificial intelligence such as the Alexa product could potentially tie-in with these services to make a holistic, personalized healthcare and wellness solution.

Foolish takeaway

Amazon's pharmacy play made headlines when first announced, but will likely fade into the background as it develops the internal PBM. Long-term investors should take note, however, of all these consumer-friendly initiatives Amazon is exploring, and how they might fit under a powerful ecosystem in the future.

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Billy Duberstein owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon and Berkshire Hathaway (B shares). The Motley Fool owns shares of Express Scripts. The Motley Fool recommends CVS Health. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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