Why CVS is making a $2B bet on stopping tobacco sales

February 5th, 2014 at 1:52 pm by under Nesi's Notes, On the Main Site

By Ted Nesi

It’s not every day that one of the largest companies in the United States announces it will voluntarily stop selling a line of products that contributes $2 billion – that’s billion, with a “b” – in annual revenue to its top line.

Yet that’s what happened Wednesday morning when Woonsocket’s CVS Caremark made the eye-catching announcement that the company will remove tobacco products from its 7,600 stores by Oct. 1. Among those who quickly praised the decision was President Obama, himself a smoker, who said CVS’s decision “sets a powerful example” and “will have a profoundly positive impact on the health of our country.”

As ISI Group analyst Ross Muken pointed out to Bloomberg, “Anytime a company puts public health and the long-term good ahead of short-term profit, it’s sort of an eye-opener.”

There’s a reason why CVS is making this move now – a number of reasons, actually. And they have important implications for Rhode Island, where CVS now employs more than 7,000 people and is the state’s biggest for-profit firm, with annual revenue that topped $123 billion in 2012.

As CVS executives made clear Wednesday, the removal of tobacco products is a major symbolic statement about how they’re trying to transform the company from a traditional drugstore chain into a health provider with a role in medical care that goes far beyond just dispensing pills. In their view, the growing emphasis in health care on improving patient outcomes and controlling costs – particularly after passage of the Affordable Care Act – has given CVS a golden opportunity to expand its presence.

“This decision really underscores our role in the evolving health care marketplace,” CVS CEO Larry Merlo, who took over from longtime CVS chief Tom Ryan in 2011, told reporters in a conference call Wednesday. “Selling cigarettes and tobacco products goes against all we stand for as a health care company.”

The most dramatic step CVS has taken to become more than a drugstore was, of course, its 2007 merger with Caremark Rx Inc., a major pharmacy-benefit management (PBM) firm. The $27-billion deal roughly doubled CVS’s size and made it a major player in the business of helping companies provide prescriptions for their employees. After a rocky start, the Caremark merger now appears to be paying dividends for CVS.

The other key component is MinuteClinic, CVS’s fast-growing chain of retail clinics, where nurse practitioners operating inside a CVS/pharmacy can provide basic treatment in a timely way at moderate prices. CVS plans to nearly double the number of MinuteClinics – from roughly 800 today to 1,500 – as they find a receptive audience among patients frustrated with the cost and complications of traditional doctor visits.

In both cases, the emphasis from CVS is on how the company can help people manage their health – but selling them cancer-causing products in the front of the store doesn’t exactly jibe with such a narrative. Peddling tobacco has also caused problems for CVS as it tries to partner with hospitals and doctors, according to CVS Chief Medical Officer Dr. Troy Brennan, who says the products come up frequently in those discussions. Merlo similarly described the decision as being about “trust.”

Still, $2 billion is a lot of sales for CVS to forego every year, even if it amounts to less than 2% of total company revenue. (ISI’s Muken estimates the amount breaks down to $1.5 billion in direct sales of tobacco products plus $500 million in other purchases by shoppers buying them.) Even if company executives sincerely think tobacco products are bad, how can they square the decision to drop them with their fiduciary duty to maximize value for shareholders?

The answer: CVS executives and board members clearly think there’s a lot more money to be made by becoming a respected and reputable member of the health-care industry than by continuing to sell tobacco products – especially with the huge amount of good publicity the company has received today. In Muken’s view, “the move will be viewed as a positive long-term decision by CVS, despite the near-term profit drag, as it paves the way for increased credibility with both health care consumers and payors.”

(Or, as Mr. Macy said in “Miracle on 34th Street” when Kris Kringle started sending Macy’s shoppers to Gimbels: “We’ll be known as ‘The Helpful Store.’ ‘The Friendly Store.’ ‘The Store With a Heart.’ The store that places public service ahead of profits. And consequently we’ll make more profits than ever before.”)

Investors don’t seem too concerned about the loss of the tobacco revenue: CVS shares were down just 0.4% to $65.83 at mid-afternoon. That makes sense: tobacco sales have been declining nationwide, while U.S. health spending will soon hit $3 trillion a year. CVS only needs to capture a tiny share of that pie to more than make up for the hit it’s expecting from the new tobacco ban. (Investors might become more concerned if CVS feels pressured to ditch, say, candy and soda.)

What does all this mean for Rhode Island?

Well, local smokers will have to buy their cigarettes somewhere else. More importantly, CVS is one of Rhode Island’s only significant engines of private-sector growth these days, with revenue up from $98 billion to $123 billion just since 2009. If the company succeeds in its transformation and continues to grow – and doesn’t shift that growth to another state – Rhode Island will have at least one big Fortune 500 success story to celebrate.

Ted Nesi ( tnesi@wpri.com ) covers politics and the economy for WPRI.com and writes the Nesi’s Notes blog. Follow him on Twitter: @tednesi

This post has been updated.

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One Response to “Why CVS is making a $2B bet on stopping tobacco sales”

  1. [...] products is an important moment for the company and a reminder of its importance to Rhode Island, as I tried to explain in my WPRI.com analysis earlier this week. The most intriguing reaction to the CVS news came from a smart Saturday Morning [...]