If the Canadian pharmaceuticals market was a high school, Domenic Pilla and Frank Scorpiniti would be the heads of rival cliques. As the CEOs of Shoppers Drug Mart and Rexall, they control the two largest pharmaceutical companies in English Canada. Along with François Coutu, the CEO of Jean Coutu, they are the cool kids of Canada’s increasingly consolidated retail pharmacy world. All of which made the sight of Pilla and Scorpiniti sharing a stage in Toronto on a recent afternoon all the more strange. Even more unlikely: the two were talking about working together. And they both had good reason to be there.
The Canadian pharmaceutical industry is under siege. Provincial governments, strapped for cash and facing ballooning deficits, have been hacking away at the prices they pay for generic drugs. Pharmacies used to be able to charge 50% or more of the price of a name-brand drug for its generic equivalent. In Ontario, where the drug reforms began, reimbursements for all generics are down to 25% of the branded price. In B.C., by 2014, the cap will be 20%. And once B.C. goes that low, “what’s stopping other provinces from following?” asked CIBC analyst Perry Caicco in a recent note.
The crackdown on drug pricing is putting the pinch on revenues across the industry. But for Shoppers Drug Mart, it comes at a particularly uncomfortable time. Eleven years ago, Shoppers Drug Mart remade itself. By opening its first large-format location, the company became a kind of department store for the 21st century, only successful and well loved. That opening set off a decade of huge and profitable growth for the company. Between 2001 and 2011, the company increased the selling space in its stores to 13.2 million square feet from 5.2 million and more than doubled its annual sales to $10.5 billion from $5 billion. Today it stands as the most profitable in its sector, and one of the most recognized and admired brands in Canada.
But after years of robust expansion, Shoppers has started to slow the pace; there are, after all, only so many drugstores one country can take. And with profits from the pharmacy counter under such pressure, some analysts have begun wondering how, if more new stores aren’t in the offing, Shoppers plans to keep growing. In February, Caicco predicted it might be 2015 before Shoppers sees earnings growth above 5% again, and that’s down from more than 16% in 2007.
Still, Shoppers didn’t become one of Canada’s most profitable companies by accident. And despite “swimming upstream” against the generic-drug changes, as Canaccord Genuity analyst Derek Dley put it in an interview, Shoppers doesn’t plan on giving in just yet. Having already gone from drugstore to superstore, it’s now looking at transforming itself into a neighbourhood medical hub as well. It’s a plan that could bring more customers through its doors and drive even more sales of perfumes and potato chips. All the company needs to pull it off is another radical rethink of what a pharmacy can be.
o understand where Shoppers is hoping to go, it helps to return to that meeting between Pilla and Scorpiniti in Toronto in April. The two heavyweight CEOs were there—along with Jeff Watson, the president of Apotex, Canada’s largest generic-drug producer—to present a plan calling for a vast expansion of the role pharmacists play in the Canadian health-care system. The plan, called 9000 Points of Care, laid out a framework that would see pharmacists treat more minor ailments, like cold sores, hay fever and back pain, administer more vaccines, and play a larger role in managing chronic conditions, like heart disease and diabetes.
At the meeting, a lunch event put on by the Economic Club of Canada, Pilla emphasized over and over again the effect the plan would have on patients. “This is really all about patient outcomes,” he said, jabbing his forefinger for emphasis.
But in the retail pharmacy world, another name for patients is customers. And converting Shoppers stores to provide more medical services could, if everything goes right, bring a lot more of those in. From a business point of view, that would be the greatest benefit of the proposed reforms, say analysts. “Absolutely,” says Dley. “More traffic is better. And repeat traffic is really why the pharmacy business model has been so successful over the last decade.”
In some provinces, pharmacists are already doing a lot more than just filling prescriptions. The Ontario locations of Shoppers Drug Mart delivered thousands of flu shots this season. And many stores now offer screening for heart disease and diabetes too. Those services will bring in some revenue, says Tammy Smitham, Shoppers’ vice-president of communications and corporate affairs. But it won’t be nearly enough to make up for the money lost as generic-drug prices are capped, she says. (The average value of Shoppers’ prescription sales fell 6% in 2012, mostly because of the generic price caps.) The larger payoff will come from old customers coming to the store more often, new customers coming in for the first time and all of them lingering in the stores, hopefully buying things other than just medical services.
Smitham cites flu shots, as one example. Patients who receive a shot have to wait around for 20 minutes afterward to make sure there are no adverse effects. That’s 20 minutes they can spend buying condoms, frozen pizzas and mascara, which means more revenue for Shoppers. The new services also offer the company a chance to hook more pharmacy clients. “We know, for example, we have a number of front-of-store customers [that buy makeup or food, for example] that aren’t pharmacy customers,” Smitham says. “That’s a huge opportunity for us.”
Of course, not everyone believes pharmacies like Shoppers Drug Mart are the best place to deliver more medical services. For starters, there are the undeniably mixed messages the stores send about healthy living. To get to the people who screen you for diabetes and heart disease at the back of the store, you have to walk a gauntlet of sugary sodas and salt-packed processed foods, that contribute to diabetes and heart disease. Smitham says the company is just offering customers a choice. Shoppers is also expanding its range of organic, and celiac and gluten-free products, she says.
Shoppers will still have to push into other areas to find growth. Even if every one of its nearly 1,300 retail stores were to start offering expanded medical services tomorrow, it wouldn’t be enough to carry it through the current turmoil unscathed, analysts say. That’s not necessarily the company’s fault. The problems are sectorwide. Caicco called Shoppers “the best actor in a bad movie” in his February note. “The company is doing everything it can to build the pharmacy business, reduce costs, and drive front-store states,” he wrote. “The trouble is the movie—it’s plagued by script problems. The provinces just find it way too easy to unilaterally lower reimbursement rates for generic drugs, and will probably continue for a while yet.”
The only plus for Shoppers is that, compared to some competitors, its business is much better set up to weather this kind of storm. Shoppers’ revenues are split pretty evenly between the pharmacy and the front-end of the store, where it sells everything else. Smaller, mostly independent, pharmacies lean much more heavily on prescription sales. As profits from drug sales drop, those independents will have a harder time staying in business. And if they’re forced to close their doors, Shoppers will be poised to scoop up their customers.
That kind of growth comes with very little cost to Shoppers, says Kathleen Wong, a retail analyst with Veritas Investment. The company is unlikely to buy the bricks-and-mortar locations the smaller pharmacies were operating out of. Instead, it will simply pick up their scrips—industry lingo for patient and prescription lists—after they go out of business, adding customers to its healthy rolls with little incremental outlay.
Wong sees scrip growth as Shoppers’ strongest prospect for adding revenue on the pharmacy end. Demographics are also on the company’s side. Prescription drug use goes up dramatically with age. As more and more baby boomers become senior citizens, prescription spending—and profits—should spike. The flip side of that, though, is that an increase in demand for prescriptions will only intensify government efforts to keep drug costs down.
Which makes it even more important for Shoppers to expand its non-pharmacy business. One way the company plans to do that is through its Shoppers Optimum points reward program, which has 10 million members across Canada. Using shopping data collected on those customers, Shoppers is now sending out individualized email flyers with specially tailored coupons.
While the chain is mostly finished with the big store openings that characterized its last decade, the stores themselves will continue to evolve. The company is adding more high-end Beauty Boutiques—stand-alone stores within stores that offer makeup, perfume and the like. And its range of high-margin luxury products continues to grow.
House brands, too, remain a priority. The company sells its own Life brand versions of almost every kind of product it offers, from food to shampoo. In May, the Supreme Court of Canada will hear Shoppers’ challenge to an Ontario law banning it from selling its own brand of generic pharmaceuticals. (The province argues private-label generics keep savings from trickling down to the consumer.) A win there would provide an important boost.
Still, for Derek Dley, a slowdown seems inevitable. “That’s what happens in Canadian retail when a company transitions from a growth retailer to a mature retailer,” he says. “Which is what I believe Shoppers is doing right now.”
Dley believes that doesn’t have to be a bad thing. Slower physical growth—in terms of stores and square footage—can mean less capital spending and more money to return to investors. But anyone hoping for the kind of stock growth Shoppers enjoyed over the past decade—when its share price climbed from less than $18 to, at one point, over $55—will be disappointed. “I don’t think we’re out of the woods yet,” Dley says. “It’s going to be a tough environment for the next couple of years.”
The real question is: What will Shoppers Drug Mart look like after those years have passed? The company is already a drugstore, a convenience store and an upscale beauty boutique, all rolled into one. Adding more medical services is the next immediate step. For now, Shoppers Drug Mart may be the name. But in the future, Shoppers Everything Mart may be closer to the reality: a retailer pushing further and further away from its roots, doing everything it can to keep customers coming through the door.