Drug Wars at the Big-Box Stores

Huge retailers like Wal-Mart and Target are cutting prices for selected prescription generics. How long can they keep it up?

In 2004, when the patent for the popular allergy drug Claritin expired, 20 pills of the generic version sold anywhere from $10 to $30, depending on the region of the country. Today, the same amount is $4 at the 4,000 Sams' Club and Wal-Mart Stores (WMT) and 1,500 Target (TGT) stores.

Price programs like that have boosted sales at both discount retailers in the latest quarter. Through them, customers can fill a 30-day prescription on drugs such as Paroxetine, the generic version of the antidepressant Paxil, and cholesterol-lowering Mevocor's generic, Lovastatin, for just $4.

The Right Prescription for Growth

In the first quarter, Minnesota-based Target saw profits jump 18%, to $651 million in the first quarter that ended Apr. 29, while sales increased 9.2%, to $14 billion. The retailer's pharmacy sales were hopping, and the increased number of folks at the pharmacy helped boost sales of other products, too.

"We are getting substantially more new guests and new prescriptions," Target President Gregg Steinhafel said May 23 on a conference call with analysts to discuss earnings. Earlier this month, Wal-Mart reported a similar sales bump. "Our pharmacy area continues to see benefits from the $4 generic prescription program," said Eduardo Castro-Wright, chief executive of Wal-Mart's U.S. operations, citing prescription sales growth that "continue to run in the mid-teens."

For Wal-Mart, the generic drugs initiative presents fertile ground for growth. Most people need monthly prescription refills, making drug sales a great way to lure customers to stores more often. "You're looking at a loss leader—the idea is they come in to buy one product and will buy three more," says Robert Passikoff, president of New York brand consultant Brand Keys.

However, Wal-Mart executives have insisted they won't sell the drugs at a loss. That's in part because the company recognizes that the generic drugs are a low-price commodity. As a result, it can employ its highly efficient logistics and technology—and the famous Wal-Mart pressure on suppliers—to squeeze out even the smallest margins that make a difference to profits at the high volumes Wal-Mart can sell.

Over at Target, though, the additional customers have come at an important cost. "Obviously [$4 generics] is putting strain on the margin rate within our Rx and pharmacy business group," says Target's Steinhafel. But he notes that the increased numbers of customers have helped sales of over-the-counter drugs and other products throughout the store.

For now, Target isn't cutting any of its pharmacy staff, despite lower margins. However, Passikoff says that lover the long term, many of these retailers might find it difficult to continue to offer such low-priced generics. "It's a game of marketing poker, and the one who can wait the longest and has financial wherewithal to invest in that strategy will win," says Passikoff.

A Scramble by Retailers

The effect has been widespread. Wal-Mart's mid-September announcement that it was launching a test program to sell 291 generic drugs for $4 a prescription in the Tampa area set off a scramble among all pharmacy retailers. Target matched Wal-Mart's offer immediately, and K-Mart (SHLD) publicized its 90-day generics for $15. Other regional supermarket stores like Giant Eagle of Pennsylvania and Meijer of Michigan even started offering a handful of generic antibiotics for free.

Consumers' response to Wal-Mart's Tampa test was so dramatic that the company decided to expand the $4 generic drugs to dozens of states just two weeks later. It's easy to understand why. The benefit for consumers was striking—the National Association of Chain Drug Stores says that the cost of a 30-day supply of an average generic prescription drug was about $29.82 in 2005, compared with $101.71 for name-brand prescriptions.

Wal-Mart's price was even lower than the $10 co-pay required by most employer health plans. "The prescriptions on our $4 program now make up more than 37% of all prescriptions we fill," says Bill Simon, chief operating officer of the U.S. Wal-Mart Stores Division. "The response nationwide has more than exceeded our expectations." Wal-Mart says the program has saved consumers more than $340 million.

The End of Unfair Mark-Ups?

The simple $4 price has certainly brought transparency to the retail drug arena. Until recently, when a drug's patent expired, pharmacies would charge as much as they liked for the generic version. While it would be far cheaper than the brand-name version, many pharmacies would mark up prices dramatically.

One study found that the mark-ups would be as high as 4,000%. For instance, in 2004, soon after the patent for the antidepressant Prozac expired, health economist Devon Herrick found that a 30-day prescription of its generic version, Fluoxetine, was selling in central Iowa for $55, in some places in Florida for $43, in Virginia for $45, and at the discount wholesale club Costco Wholesale (COST) for $7.09.

"People are just not aware of these variations, and most of them don't compare prices," says Herrick, a senior fellow at the National Center for Policy Analysis, a nonprofit research group. "Pharmacies take advantage of consumers' lack of knowledge and mark up prices substantially."

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