McKesson's Booster Shot

The problem: huge sales, tiny profits. High-margin tech products could help

McKesson Corp. holds the unenviable distinction of being one of the world's biggest yet least profitable companies. The San Francisco drug distributor has $88 billion in annual sales, making it the 16th-largest company in the U.S. But during the year that ended Mar. 31, McKesson (MCK ) squeezed out just $751 million of net profit. Ever since it started delivering drugs by horse-drawn wagon in the 1830s, it has tried to boost efficiency in an inherently low-profit business. The result: 3% gross margins in drug distribution.

No surprise, then, that Chief Executive John H. Hammergren is looking for ways to build a healthier bottom line. One strategy has been to expand into the high-margin business of selling technology to doctors, hospitals, and insurance companies. McKesson's move started inauspiciously: In 1999, the company acquired software maker HBO & Co. for $12 billion, and then discovered that its previous management team had artificially inflated revenues. Last year, McKesson paid $960 million to settle a securities class action that was filed as its stock plunged. With scandal in its rearview mirror and with improving cost trends in distribution, McKesson's stock has returned 14.8% in the past year, compared with 2.6% for the S&P 500 Health Care Index (S5HLTH ). The company reached No. 48 on the BusinessWeek 50 list of the top-performing big companies.

Some of McKesson's new tech offerings aim to transform the way patients interact with doctors. Instead of waiting on hold, they can log on to the Web to zap questions to their physicians and even have virtual visits with them. Rather than trying to build technology knowhow from the ground up, McKesson has been snapping up innovative startups, bringing in a wide range of expertise. In May it acquired billing software maker HealthCom Partners, and in June it picked up RelayHealth, which has developed a Web-based office management system for doctors. "We're filling out the white space between our solutions," Hammergren says.


The financial rewards are fast becoming evident. Although the technology unit accounted for just $1.5 billion of McKesson's sales in the most recent fiscal year, its gross profit margin was 46.7%, astronomical compared with drug distribution. Eric W. Coldwell, an analyst for Robert W. Baird & Co., estimates that its sales will grow 25% by 2008, while the drug distribution side will grow just 13%.

Health-care IT is a fragmented, fiercely competitive business, however, with rivals ranging from General Electric Co. (GE ) to Cerner Corp. (CERN ) scrambling to get systems into doctors' offices and hospitals. McKesson's ability to automate all health-care players -- doctors, hospitals, insurers and patients -- could give it an edge. "There are not a lot of competitors who offer integrated solutions," says John W. Ransom, an analyst for Raymond James Financial Inc. (RJF )

Customers say McKesson's solutions are more nimble than its rivals'. RelayHealth, for example, is designed to link to many different hospital systems regardless of whether they're sold by McKesson. And it offers time-savers such as the ability to order prescriptions via the Web. "When I call prescriptions in, I get put on hold, I get angry, I hang up," says Dr. Richard U. Levine, president of the faculty practice organization at Columbia University, which has begun outfitting its physicians' offices with the software. "With Relay it's more efficient, and I don't have to worry about a pharmacist misreading my handwriting."

While boosting its IT presence, Hammergren has also been selling off McKesson's least profitable units. Coldwell estimates that McKesson's overall gross margin will rise from 4.2% in 2005 to 4.4% in 2008. That may not sound like a big deal, but it's a step in the right direction. "McKesson is going through portfolio cleansing," Coldwell says. "It's exactly what they need to do."

By Arlene Weintraub

    Before it's here, it's on the Bloomberg Terminal.