The market forces influencing the performance of US drug store chains.
The intent of this article is to identify the most significant performance trends which have taken place in the American drugs store industry during the 1980s and to relate these trends to underlying market forces.
In the 1970s, as supermarkets and discount department stores (such as Wal-Mart and K-Mart) began filling prescriptions, many retail prophets forecast the decline of the traditional pharmacy (drug store) in the United States. A review of recent statistics, however, reveals that the drug store industry is expanding both in sales performance and store count.
Total drug store sales increased by approximately 7 per cent between 1989 and 1990 compared to a total retail sales increase of 4 per cent. In fact, drug store sales grew faster than those of any store type, except discount department stores. The 7 per cent increase came despite a weakening recession-bound economy in which most retail store types had trouble keeping pace with a 5 per cent inflation rate. Some analysts attribute this performance to drug stores being more "recession proof" than other lines of retailing. However, drug store sales improvement has outpaced total retail sales growth in seven of the past ten years[1, p.2] certainly not the symptom of an industry in atrophy!
Chain drug stores account for about two-thirds of all drug store sales and their sales growth was an even more impressive 8.5 per cent compared to the 7 per cent achieved by all drug stores. However, an examination of their sales by department and product group (Table I) reveals that this increase was not evenly distributed throughout the store. [Tabular Data 1 Omitted]
In 1990 prescription sales grew by 14 per cent over the previous year, to $14 billion dollars, and this accounted for no less than 52 per cent of the entire growth of sales in chain drug stores. The growth in prescription sales is only partially explained by the 10 per cent increase in prescription drug prices and, therefore, represents real growth. As the statistics presented in Tables I, II and III indicate, this has been a consistent trend since 1981 and prescriptions now account for almost one-third of total drug store revenues, up from 25 per cent in 1981. This is a significant pattern for the industry and has consequences for the future of store merchandising and operations. [Tabular Data 2 and 3 Omitted]
Within the prescription department, a pronounced trend is the growing number of "third party" scripts. These are prescriptions that are not paid for directly by the customer but are billed to a third party, such as an administrator of an employee health policy or a government agency. Profit margins are generally lower for third party prescriptions and, therefore, their proportion of total scripts sales impacts a store's profitability.
The trade journal Chain Drug Review, reports that currently about half of all prescriptions filled are third party and that this proportion may approach 90 per cent by the year 2000. This percentage, of course, will be influenced by the outcome of health care insurance legislation now being debated in the US Congress. As part of this debate, there may be restrictions that third party administrators are able to place on who can fill a prescription, such as only ordering by mail or through "qualified" retail outlets. Restriction such as these could be strong determinants of the distribution of future prescription market shares.
As prescriptions increase their proportion of total drug store sales, mathematics dictates that other departments must decline in significance. No single drug store department has displayed a dramatic drop in share of total pharmacy store sales but a number have shown a gradual decline. General merchandise (toys make up almost a third of this division), housewares, tobacco, and consumables (liquor, wine and beer account for over one-half of consumables) have not increased their sales as rapidly as the other departments over the past ten years. This is mainly due to increased competition for these product lines from other types of retailer and the changing life styles of consumers.
The drug store share of the growing health and beauty aid market (over-the-counter drugs, toiletries and cosmetics departments) has been severely challenged by discount department stores and food-drug combination stores over the past two decades. Chain drug stores have however, managed to maintain health and beauty aid (H&BA) sales at about 30 per cent of total store sales. Under similar competitive circumstances, the stationery, photographic, and confectionery departments have held their combined ratio of total store sales to 13 per cent.
The unrestrained growth of the large discount drug store, the decline of the small independent drug store and the consolidation of drug store chains highlight the changes in formats that have taken place over the last decade.
The large discount drug store is a 20,000-60,000 sq. ft store carrying traditional drug store merchandise, sold at discount prices and dependent on high sales volume (turnover) for profitability. Investments in fixtures and customer service are minimal and the inventory is customarily purchased in large quantities from a manufacturer at a "deal price" or close-out price.
Deep discount drug store sales are estimated at about $5 billion or 7 per cent of total drug store sales. The concept is dominated by three companies; Phar-Mor, Drug Emporium and F&M who account for about two-thirds of all the large discount drug outlets in the United States. Phar-Mor illustrates the explosive ascent of this store concept. The company consisted of 36 stores in 1986 but by 1990 it had 237 units with annual sales in excess of $2 billion. Reportedly the firm has plans to add another 70 stores in 1991.
The growth of conventional drug store chains has been less spectacular, but the long-term trend is unmistakable. Small independent pharmacies and small drug chains are disappearing, while the well-managed large chains remain viable retail entities.
As stated, total drug store sales increased 7 per cent between 1989 and 1990, but the sales of drug chains grew at a rate of 8.5 per cent compared to only a 5 per cent increase for independent pharmacies. More telling is the fact that medium and small independent stores actually recorded sales declines of 6 per cent and 10 per cent, respectively. Drug chains of four or more units now account for about two-thirds of all drug store sales. Their average volume is $2.3 million for an average size of 8,650 sq. ft, which yields a sales per square foot of $270.50.
The number of chain drug companies has actually decreased 36 per cent since 1980, but the number of chain drug stores has increased by 23 per cent. Chains of 11 or more units increased their store count by 56 per cent in this time period, while chains or four to ten stores evidenced an opposite trend, reducing outlet count by 23 per cent. Chains with fewer than four stores experienced a 40 per cent reduction in their store count.
The performance of a drug store chain is determined to a great extent by the skill and dedication of its employees and the acumen of its senior management. However, there are underlying market currents of which managers must be aware in order to set the proper course for their company.
Three of the most significant forces that shape retailing in the United States, namely demographic characteristics, the state of the economy and the competitive environment have all recently altered their direction. These forces are very much intercorrelated and it is difficult to separate their impact. Nevertheless, these changing currents are responsible for some of the trends noted above and will certainly continue to influence the performance of drug stores in the future.
The three most potent demographic pressures that have exerted themselves on the drug store industry over the past decade are:
(1) the deceleration of population growth;
(2) the ageing of the population; and
(3) the lifestyles and characteristics of "baby boomers".
Population growth has been the energy source for retail expansion since the end of the Second World War. It has fuelled the demand for new products and services, housing, schools and employment. Growth could cover up many mistakes in retail operations and even mundanely managed companies could prosper.
This rapid increase in population, termed the "baby boom", began to slow down in the mid-1960s. But household formation, the basic buying unit for most retail goods, continued to increase into the 1970s and 1980s as baby boomers formed their own households. In addition, as the mortality rate dropped, there were more older Americans to boost retail sales. These two factors helped to maintain consumer demand during the past two decades.
The growth rate for the decade between 1980 and 1990 (9.8 per cent) is the second lowest recorded since the United States Census began in 1790: only the Depression decade of the 1930s was lower. However, many companies have continued to manage their businesses based on assumptions of continued strong population growth. While they may blame their deteriorating performance on increased competition or the economy, some have simply failed to adjust to a trend that has been evident for 20 years. A comment by Kathleen O'Connor summarises the new environment very well.
Demand will be flat and competition up. For every new door that opens, there will be another that eventually will close. For every winner, there will be an eventual loser.
On the positive side, since the population base is larger, the 9.8 per cent increase between 1980 and 1990 amounted to the addition of 22 million people to the US population, the fourth largest increase in US history. Average household size continues to decrease and, therefore, the growth in households, 16 per cent, continues to outstrip total population growth.
The most obvious pattern of population change in the US is its geographic distribution:
The South and West together accounted for 89 per cent of national population growth in the 1980s...Their combined share of the national population increased from 48.0 per cent in 1970 to...55.6 per cent in 1990... Thehe combined population growth in California (6.1 million), Florida (3.2 million), and Texas (2.8 million) in the 1980-90 decade totalled... 54 per cent of the... national population increase. This is the first time in the nation's 200-year census history that as few as three state accounted for over half of the national population growth.
If the analysis were carried to another scale, it would be seen that most of this increase was in metropolitan areas and, therefore, growth is very concentrated. In these urban centres where population growth still fuels retail sales, the expansion of sales and store count experienced in previous decades is still the norm.
Meanwhile, much of the Northeast and Midwest and many rural areas of the South and West are experiencing a no-growth situation. American Demographics magazine has identified an ever increasing group of urban areas they call "flatliners". Flatliners are metropolitan areas that gained or lost less than 2 per cent of their population during the 1980s. Most of them are in the Northeast or Midwest.
Retailing is obviously more difficult in this lowg growth situation. There may be some growth in the suburbs as the central city declines, but these opportunities are limited. As American Demographics explains:
Markets that are growing slowly and are saturated with competition leave businesses with a tough choice. The only way to grow in such an environment is to steal business from someone else.
Ageing of the Population
As the birth and the mortality rates have declined, the percentage of senior citizens has increased. There are an estimated 33.2 million people over the age of 65 in the US or 13.3 per cent of the population, up from 11.3 per cent in 1980. As the population ages, their buying habits change. Concerns about health, financial security and retirement activities replace the purchase of suburban homes and cars. Shopping patterns of seniors become well established.
Also as the population ages, the percentage of people living alone arises sharply from 15 per cent among 35-44-year-olds, to 25 per cent among 55-64-years-olds and 37 per cent among 65-74-years-olds.
In fact, much has been written about the decline of the "traditional family" in America. The frequent implication is that changing social mores, the rise of non-traditional families and couples who have chosen not to have children are the primary generators of this pattern. While all of these characteristics are true, the ageing of the population contributes as much as this statistic as changing social attitudes. "Empty nesters:, couples whose children have grown and left home, and the elderly single-person household have caused a dramatic shift in household structure.
The Baby Boomers
While the traditional family, married couples with children under 18, may have fallen to an all-time low of 26 per cent of all households, within baby boomer households the percentage of traditional families is 46 per cent.
The baby boom generation, those born between 1946 and 1965, account for one-third of the nation's population and 44 per cent of all households. Because of their sheer numbers they have controlled retail spending in the US and will continue to do so. As this generation was formed, it fuelled the growth syndrome discussed earlier. Now that they have matured and formed families of their own, their needs have changed but their control over retail spending has not.
It is also important to remember that as this dominant group ages its needs will continue to change. "The baby boom is a moving target. Moving with it is the key to economic growth.
After nearly eight years of expansion, the US economy slipped into a recession in 1990. In early 1991 the gross national product (GNP) continued to drop, as did other indicators, such as total employment, construction starts and total retail sales. The recession has been attributed to the Gulf War and the loss of consumer confidence in the economy. Most analysts contend that the downturn will end in the second half of 1991, but the recovery will be weak and slow.
THE FASTEST-GROWING TACTICS ARE SALES AND PRICE SPECIALS
While the 1980s may have been an era of expansion, it was probably the most uneasy expansion in history. Throughout the decade there were doubts raised about certain fundamentals of the economy. Questions involving the federal deficit, the Savings and Loan bail-out, slow growth in population and housing, and the shift from an industrial base to a service-base economy were frequently discussed. Stagnating real personal incomes, rising taxes and expenses, along with job changes caused by bankruptcies and leveraged buy-outs caused anxieties on an individual level.
The consequences of this shift in economic forces for retailers, including pharmacies, are: (1) a consumer obsession with price and value; (2) the construction of only a limited number of new shopping centres; and (3) an increase in bankruptcies and acquisitions.
In Monitor magazine's annual survey of shopping centre developers and retailers, the fastest-growing competitive tactics being used by retailers are sales and price specials. The meteoric rise of the large discount drug store is also another indication of the price sensitivity of the contemporary buyer. However, there is also a recognition of value by some consumers. A purchaser frequently is willing to invest in a perceived "added worth", such as convenience, service or quality. But it must be an obvious value.
SMALLER SHOPPING CENTRES ARE THE MOST LIKELY TO GAIN LOAN APPROVAL
The second result of recent economic trends is the precipitous decline in new shopping centre construction. Through the first half of 1990, shopping centre construction starts fell 24 per cent. According to the International Council of Shopping Centers, "it has been the industry's worst period since the last recession". The same organisation estimates that the annual loss to the national economy due to this decline is approximately $6.9 billion. This decline is being experienced in all regions of the country, with the Northeast and Midwest being hurt the most.
The aftermaths of overbuilding and the poor commercial property investments of the 1980s are now being realised and lending agencies have become very strict in their loan requirements. As a consequence, the opportunities for new shopping centres will be scarce in the near future. To the advantage of the drug store industry, smaller shopping centres with a lower investment cost, proposed by financially solid developers are the most likely to gain loan approval. However, even these loans will be limited in number.
With fewer shopping centres being developed, the remodelling of vacant space in existing centres, the construction of free-standing stores and the acquisition of competing operations, are the most likely paths of growth in the short term.
A final consequence of current economic trends is the buyout, bankruptcy, and acquisition pattern exhibited by American retailers recently. The drug store industry has been swept along in this current. In 1990 alone, Melville's (CVS) purchase of People's 490 stores, Fay's acquisition of 48 Carl's units and Pay Less's agreement to buy 51 Osco stores are all notable examples of acquisitions. Revco's initiating of a Chapter 11 filing and its planned sale of 700 stores illustrates the more drastic alternative of bankruptcy.
As the economy continues to be anaemic, marginal operators, overextended companies and conglomerates who are redirecting their priorities will depart, leading to a further consolidation of the drug store industry into the hands of the larger better-managed chains.
Many of the well-operated drug store chains have found it difficult to achieve sales gains during the last decade due to the continuing intrusion of other retail formats into drug store product lines.
In the early 1970s, the drug store lost its virtual monopoly of the prescription business as supermarket companies began to develop their food-drug "combo" concepts. This term symbolised the combination of a supermarket and drug store into one operation. Customers could have their prescriptions filled while they shopped for groceries. The idea has become well accepted by the shopping public and most of the larger supermarket chains have committed themselves to the concept. According to Chain Drug Review, 10 per cent of all prescriptions in the USA are now filled in supermarkets.
Drug store counters are to be found in 35 per cent of Safeway stores, 40 per cent of Kroger supermarkets and 50 per cent of Albertson's units. These percentages continues to grow as most of their newer supermarkets are of the food-drug combination format. The trend towards this store type is not only present in national chains, but is common among many regional and even local supermarket operators.
The commitment to pharmacies by the discount department store industry has been far less pervasive. The percentage of stores with a prescription counter is very small in most discount chains. Unfortunately for drug stores, the two chains that appear to be most dedicated to the idea are Wal-Mart and K-Mart. These are the two largest retailers in the US and both have publicly proclaimed that a drug store operation is an integral part of their future store plans.
Approximately 69 per cent of Wal-Mart's units have a drug store. Wal-Mart's heady goal of 3,000 stores and $130 billion in sales by the year 2000 would certainly bring the discount department store pharmacy into many new neighbourhoods. K-Mart's 1,200 pharmacy departments in its 2,300 stores currently make it the fifth largest pharmacy operator in the US, by store count. Their "strategic plan calls for 1,800 pharmacies and $2 billion to $3 billion in pharmacy sales by 1995".
Outside the pharmacy department the competition faced by drug store retailers is even stiffer. The aforementioned food-drug combos and discount stores have made significant inroads into the health and beauty aid (H&BA) product category.
THE LARGE DISCOUNT PHARMACY FITS THE CATEGORY KILLER DEFINITION
The original food-drug combos were about 50,000 square feet in size, but many of the newer versions exceed 100,000 square feet and have an enormous breadth and depth of product variety. The combo's appeal for one-stop shopping and the variety and selection of its merchandise have impacted on many pharmacies.
While discount department stores in general have not taken to the idea of a pharmacy, they all have heavily promoted health and beauty aids. In fact they have increased their market share in this category by 3 per cent since 1984 mainly at the expense of drug stores. As mentioned earlier, drug chains have done well to maintain H&BA sales at a constant 30 per cent proportion to total stores sales against such strong competition.
In other product lines, the drug stores have not fared as well. One reason for the loss of market share in some product lines is the advent of the "category killer" retail store concept. These are speciality discount stores that concentrate on one category of merchandise, sell it at low margins in a warehouse atmosphere and depend on large volumes for profitability.
Examples of this retail concept are Toys R Us (toys), Circuit City and Silo (electronics), Office Depot (office supplies) and Home Depot (DIY products). These stores offer very low prices and wide selections and they have impacted on sales in many retail operations that handle the same categories, including drug stores.
The large discount pharmacy discussed earlier fits into the category killer definition. As mentioned under the discussion of store formats, the large discount drug store is a growing concept within the chain drug industry. Although they only account for approximately 7 per cent of pharmacy sales nationwide, individual store volumes may approach $100,000 per week. Therefore, their impact on a local trade area may be very substantial. It is almost impossible for a traditional pharmacy to complete successfully with them on price.
The competitive concepts discussed above, combos, discount department stores and "category killers", all share some common characteristics. They all tend to be large stores requiring geographically extensive trade areas and significant sales volumes. Therefore, they must be spaced a good distance apart, losing some of their locational convenience and neighbourhood character.
What does the preceding discussion imply for the immediate future of the drug store industry? The elements of the marketplace of the 1990s seem to favour the opportunistic, well-capitalised chain, while the future for independents, small chains and the marginal or inflexible operator is gloomy.
The American consumer has formed the definition of the pharmacy as a specialised provider of health and personal care products. The industry would do well to accept the definition. Prescription sales have increased from one-quarter to one-third of total store sales over the past ten years. Walgreens, the largest and most profitable drug store chain in the country, has mirrored this trend. They look forward to prescription sales climbing to 50 per cent of total store sales by the year 2000. "Other stated mission is to be the most convenient healthcare retailer in America", says Charles R. Walgreen, chairman (their italics). With an ageing baby boom population, demographic trends seem to favour this mission.
A national health care system would also increase prescription dollar potential by making it available to a larger segment of the population. A national health programme would probably increase the number of lower margin third party prescriptions. But, it would also neutralise the attraction of price, the major advantage, for most competitor, of drug stores. If price is not an issue, then more importance would then be placed on other attributes such as convenience, professional image, and service.
These attributes fit well into the current trend of target marketing, or the "localising" of a store's products to its trade area. Because it can exist on a smaller population base than its larger competitors, a drug store can be more neighbourhood oriented. In addition to prescriptions, over-the-counter medicines, personal hygiene products and cosmetics geared to local demand and presented in an atmosphere of service and quality could enhance this image of a specialised provider of health and personal care products.
Finally, there are two more factors favouring the growth of the traditional drug store. First is that the demand for these products is consistent and, therefore, their provider is less likely to suffer during difficult economic times. Finally, the short-term credit problems of shopping centre developers will also tend to favour the building of smaller centres, the usual locations of drug stores.
This favourable tide, however, is not without its undertow. Consumers whose shopping decisions are based mainly on price will be lost to the traditional drug store. Discount department stores, food-drug combos and "category killers" operate on lower profit margins and offer lower prices. A traditional drug store whose major marketing tool is price may suffer in competition with them.
Outflanking the larger competitive store types with more convenient locations is certainly a tactic that will attract sales. But unless there is a perceived "added value" received for shopping at the store, some consumers may be willing to trade convenience for better value. A knowledgeable and helpful pharmacist, good service, or the impression of a large selection may constitute an added value.
Except in a few metropolitan areas with large population increases store growth by one drug chain will be at the expense of other chains or independents. There are very few under-stored areas in the United States, Therefore, financially strong chains who pay attention to market trends will grow at the expense of others.
Companies with larger capital resources are also more able to invest in technological advances which held to control or reduce expenses. Point-of-sale computers, inventory control software and distribution systems all require a considerable investment spread over a large store base. Once in place, this technology provides the user with a significant competitive advantage.
The drug store performance trends identified at the beginning of this chapter: (1) sales increased greater than the retail average, (2) an increasing percentage of prescription sales to total store sales, (3) flat H&BA sales, (4) falling general merchandise sales, (5) fewer independent operators and, (6) fewer but larger drug store chains, are all trends that are likely to continue into the next century.
[1.] 1990 Annual Review of Drug Store Trends, A.C. Nielsen Co., 1991. [2.] Mass Market Retailers, 29 April 1991. [3.] Chain Drug Review, 25 March 1991. [4.] Mass Market Retailers, 13 May 1991, p. 35. [5.] Drug Store News, 6 May 1991, p. 25. [6.] O'Connor, K. M., "Bridging Demographic and Retail Realities", Shopping Center World, May 1991, p. 50. [7.] Population Trends and Congressional Apportionment, 1990 Census Profile, US, Department of Commerce, Bureau of the Census, March 1991. [8.] "This World is Flat", American Demographics, April 1991, pp. 34-9. [9.] Russell, C., "On the Baby-Boom Bandwagon", American Demographics, May 1991, p. 31. [10.] "5th Annual Report of the Shopping Center Industry", Monitor, April 1991, p. 38. [11.] "Anatomy of a Credit Crunch", ICSC Research Bulletin, 1990, p. 1. [12.] Chain Drug Review, 17 June 1991, p. RX2. [13.] Walgreens Annual Report, 1990, p. 11.
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|Title Annotation:||American Retailing: The 1990s|
|Author:||Haake, John H.|
|Publication:||International Journal of Retail & Distribution Management|
|Date:||Nov 15, 1991|
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