The Real Reason CVS Stopped Selling Cigarettes

By Catherine Chen

In a shocking and unprecedented move, pharmacy and retail behemoth CVS Caremark announced earlier in February that its more than 7,600 retail pharmacy stores will stop selling all cigarette and tobacco products by October 1st of this year. Anti­tobacco and public health lobbying groups such as the American Cancer Society have praised CVS for its seemingly progressive, people-­first, profits-­second motive.

President Barack Obama, himself a former smoker, applauded CVS and its “national campaign to help millions of Americans quit smoking.” However, contrary to the President’s remarks, CVS’s decision to end tobacco product sales is in fact more strategic than altruistic. CVS’s true aim is to orient away from its convenience store image in order to capitalize on the booming pharmacy and healthcare provision industries. 

Just the Numbers. 

Analysts estimate the decision to forgo cigarette and tobacco sales will cost CVS about $2 billion in lost revenue in 2014 and similar amounts for the foreseeable future. The net financial impact, however, will be miniscule, if not negligible. Tobacco sales account for less than 2% of CVS’s revenue, and by all accounts CVS is in good financial health otherwise.

Last year CVS’s net revenues experienced 3% year­on­year growth to $126.8 billion and net income increased by 18.8% to $4.6 billion, both of which were nearly double those of its nearest competitor, Walgreens. CVS’s market capitalization is nearly one third greater than Walgreens’, and in 2013 CVS Caremark ranked fortieth in the Fortune Global 500 list of the world’s largest companies – the thirteenth largest in the United States. CVS’s share price has risen by over 42% in the past year. In addition to strong financials, CVS’s business structure is also well suited to transition towards healthcare provision.

Figures provided by CVS indicate that 54.2% of its revenue and more than one third of its profits come exclusively from the sale of prescription drugs from its Pharmacy Services Segment. Thus it is prudent that CVS now looks to orient its business structure and brand image to focus more on healthcare provision than consumer retail. Moreover, with over 750 MinuteClinics – CVS’s walk­in health centers – and contracts with over 250 commercial and government health plans, including Medicare Part D, CVS is physically well­suited to provide limited, albeit cost­effective, healthcare services. This strategy was affirmed in CVS’s 2013 Form 10­K, where the company reported that its stores’ focus is “shifting from primarily dispensing prescriptions to also providing services.” Accordingly, CVS plans to open nearly 150 new MinuteClinics in 2014.

HEALTHCARE INDUSTRY TRENDS: NOWHERE BUT UP

CVS booted tobacco products from its shelves in order to build its image as a legitimate healthcare provider. By ridding its shelves of products that are responsible for an estimated 443,000 deaths each year, CVS will pave the way for better relationships with doctors, hospitals, insurance providers, and a public in high demand of healthcare services.

In 2011, The World Bank reported that $2.78 trillion, 17.8% of US GDP, was spent on healthcare. The Centers for Medicare and Medicaid Services (CMCS) estimates healthcare spending is expected to increase at an annual rate of 5.8% from 2012-­2022, outgrowing projected annual GDP growth by atleast 1% during this period. CMCS’s findings identify improving economic conditions, increased insurance coverage, and an aging population as the major factors driving this growth. By rebranding itself as a legitimate healthcare provider, CVS is poising itself to scoop up more of this increasingly lucrative pie.

Much of this increasing insurance coverage will stem from the implementation of The Patient Protection and Affordable Care Act. Passed in 2010, the Affordable Care Act is a major driver of the push towards healthcare provision for CVS and competitors like Walgreens, which after CVS’s announcement to end tobacco sales conceded that it too was “evaluating this product category.” Already, insurance companies and other third­party payers account for nearly 85% of the payments made to MinuteClinics. CVS itself estimates that 82% of those eligible to use Obamacare exchanges have existing relationships with the company and has high hopes for the revenue stream coming from those newly insured under the public exchanges formed by the ACA. Private exchanges, i.e., those operated by insurance companies, on the other hand, offer a less rosy future for CVS. According to Morgan Stanley, by 2017, these private exchanges may include up to 30 million people, mostly employees or former employees of large corporations. CVS stands to lose around 5% of its business as companies like Xerox, which previously had contracts with CVS, move their retired workers to private exchanges.

The net result for CVS, however, will be positive. Though the company stands to lose some business due to lost contracts, it stands to gain much more from more public dollars entering its MinuteClinic and pharmacy coffers. Thus, ending tobacco product sales in a healthcare services center is not only the “the right thing to do” as CVS put it, but also the right and profitable thing to do.