Should JNJ Acquire Walgreens? Should Pfizer?
The ‘magic quadrant’ for a pharmaceutical company to increase shareholder value happens by inventing a new peer group. The process starts with an atypical playbook.
“Wall Street has been eager for change at Pfizer [and Bayer and Biogen and Bristol-Myers Squibb and Moderna and CVS Health and Rite Aid and Walgreens and Nestlé and Teladoc Health] but even before Read and D’Amelio split from Starboard, analysts and shareholders were skeptical that the typical activist investor playbook would work on the struggling pharmaceutical company
“There’s no low-hanging fruit. If a company is overspending, you can stop the overspending. If a company has too much fat, you can cut the fat. Pfizer doesn’t have that,” said one top-10 investor, adding that they thought it was unlikely much would change as a result of Starboard’s campaign. Starboard’s most famous brush with the pharma sector, when it opposed BMS’ $74bn takeover of Celgene, came to little, even if the investment still turned a profit.
The crucial long-term question for Pfizer is whether its pipeline can bear fruit. In particular, shareholders are watching to see if its $43bn buyout of cancer drugmaker Seagen which was completed last year will deliver eight blockbuster medicines by 2030 as promised and whether it can gain a foothold in the lucrative weight-loss drug market with its experimental pill danuglipron.”
— from Starboard Plotted a Campaign Against Pfizer’s Chief. Then a Blank Email Dropped in his Inbox by Oliver Barnes, Maria Heeter and James Fontanella-Khan in the Financial Times, October 10, 2024
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An Atypical Playbook
Where the analysis misses is in the synthesis.
The “drug market” is actually a loosely-coupled system of markets. Technically, it’s a ‘system of systems’ around which hundreds of billions of earnings and investments and projections — and shareholder value — is pegged.
These are the markets researching and producing the drug factor to healthcare, the physical product that gets studied, developed, supplied and promoted to prescribers and their patients. The shorthand to reference this complexity is “the ecosystem” which is out there somewhere in the ether, a galaxy whose central bulge is comprised of a CRO market (roughly $133 billion), a commercial pharmaceutical analytics market (roughly $13 billion), a drug wholesale and distribution market (roughly $844 billion), an advertising and marketing market (roughly $400 billion), a contract sales market (roughly $16 billion), a pharmaceutical CRM software market (roughly $6 billion) and, of course, the artificial intelligence drug discovery market (still small and figuring itself out, roughly around $2 billion).
All of this gets applied to creating $714 billion in sales for prescription drugs in the United States alone.
The first cousin of the ‘drug market’ is the ‘retail pharmacy market’ — pharmaceutical market access teams think of retail pharmacy as The Channel for the pipeline.
Retail pharmacy is the rapidly-becoming irrelevant infrastructure, ideally within a short walk or drive, where the “patient” (using the language of a pharmaceutical brand team) or “shopper” (using the language of a soon-to-be-laid-off retail pharmacy manager) or “mom” (to use the language of most families — 78 percent of women identify as the primary household shopper, according to Supermarket News) visit to get the drug product produced and promoted by the $1.4 trillion economic system described above. (Hopefully, for the professionals at said retail pharmacy whose career and bonus is pegged to “pharmacy growth and innovation” and/or “customer loyalty” and/or “transformational change”, the patient-as-shopper-as-customer will have the patience to tolerate the miserable experience these places have become, and pester a store clerk to unlock the Hot Pockets or a bottle of Diet Coke while waiting in line at the pharmacy counter.)
Retail pharmacy is another one of those “ecosystems” — out there somewhere in the ether — whose central bulge is a pharmacy management software market (roughly $90 billion), an e-commerce technology market (roughly $10 billion), a retail supply chain management market (roughly $60 billion) a retail logistics market (roughly $800 billion) and an organized retail crime/shoplifting market (roughly $100 billion). The latter is growing at more than 50 percent a year.
Sitting astride all of this is the Big PBM market.
In ecological terms, Big PBM are the apex predators OptumRx, ExpressScripts and CVS Pharmacy, three companies who control almost 90 percent of the market in pharmacy benefit management, which is valued at around $520 billion.
At a system level, Big PBM powers the self-organizing behavior of both the ‘drug market’ and the ‘retail pharmacy market’ in the Untied States, in the sense that the pressure to survive — much less grow, innovate and increase shareholder value — depends on successfully rotating in their orbit. Big PBM, more than the healthcare professionals and the pharmaceutical industry, controls the practice of medicine in the United States because it defines the rules of play in the drug market, including its economics.
They are the gatekeepers.
These are the middlemen who have a variety of tools at their disposal, developed over decades, to help insurance plans manage prescription use and cost — such as requiring prior authorization before a patient can fill a prescription, or putting quantity limits on the amount of a medication that a customer can purchase through their insurance plan, or ensuring “utilization management, or even weaponizing the fax machine to deploy “passive contracts” as a form of market control.
From Barron’s last week (Confidential Files Detail PBMs’ Backroom Negotiations — and Their Role in the Opioid Crisis):
“PBMs’ days of obscurity might be ending. The Federal Trade Commission recently accused the industry’s largest players of inflating insulin prices. The PBMs say they have worked to make insulin more affordable and have vowed to defend themselves against the FTC lawsuit.
Barron’s reporting raises fresh questions about the companies’ involvement in the pharmaceutical supply chain.
PBMs receive billions in fees and rebates from pharmaceutical companies seeking to guarantee that their products get in front of insured consumers. Through their management of so-called formularies, PBMs have the power to grant drugs preferred spots versus competing products; place restrictions on drugs, like requiring prior authorization; or to exclude certain products altogether. The industry is dominated by CVS Caremark, UnitedHealth’s Optum Rx, and Cigna’s Express Scripts. Together, they control nearly 80% of the market for prescription claims.
The industry records viewed by Barron’s stem from years of opioid litigation across the country. They’re now held in the Opioid Industry Documents Archive maintained by University of California, San Francisco, and Johns Hopkins University.
The documents show how financial terms negotiated by PBMs are intertwined with the availability of medicines to consumers….”
In other words, if you’re a pharmaceutical brand team, don’t piss off Big PBM, lest you’ll find your brand/business unfavorably positioned on the formulary.
Which means all the investments made in discovering and developing a drug’s technical potential, and the potential forecast and shareholder value around said technical potential, will be under-realized, under-performing and subject to revision.
Which is why Starboard is misreading and misunderstanding ‘the market’ in which it just invested $1 billion.
Just Ask Walgreens
When you connect both of these markets, and understand them strategically as a single economic system, they constitute a big part of the $734 billion investment employers spend every year on healthcare (data from Trilliant Health).
Part of the reason drug store chains are struggling is because of falling reimbursement rates for prescription drugs and higher fees imposed on them by Big PBM. The retail pharmacy market has complained bitterly that PBMs have too much control over the industry and can squeeze pharmacies.
“If reimbursement rates start to come down and drug stores can’t offset it with other growth, then it has a negative impact on their profitability,” says pretty much everybody, but the quote goes to Elizabeth Anderson, an analyst at Evercore IRI in Why Walgreens, CVS and Rite Aid are Closing Thousands of Drug Stores Across America, “At the same time, the rest of the store that’s supposed to pad the margins aren’t doing it so much anymore.”
Around 25 percent of Walgreens’ stores aren’t profitable.
No doubt, it's been a difficult couple of decades for Walgreens, which has seen its stock lose two-thirds of its value this year alone. It currently trades at levels not seen since the 1990s.
Walgreens, like Pfizer, has fallen victim to consistent drops in drug reimbursement payments from Big PBM over the years, not too mention a poor acquisition Walgreens made to position itself in primary care, as well as a cost-conscious consumer demanding a different pharmacy experience altogether.
Which raises a “crucial long-term question” for Walgreens in its search for strategic direction: why carry products at all? And for Pfizer: why depend on Walgreens as a channel? Cue the real existential threat/opportunity to its model: The Amazon Way of competing and creating shareholder value.
The retail pharmacy market has long been considered e-commerce proof, writes Geoffrey Seiler, in a market commentary for The Motley Fool on Sunday. “While there have been mail-order and e-commerce pharmacies for quite some time, catering to people with predictable prescription refills, many patients need their medicine immediately, not in a few days.”
“However, Amazon is now looking to turn the industry on its head by rapidly expanding its same-day pharmacy services. Amazon began its e-commerce pharmacy service in 2020 and started testing same-day delivery in a few select cities last October. It expanded to the greater Los Angeles area and New York City in March and now has ambitious plans for 2025.
The e-commerce giant now plans to offer same-day pharmacy services in 20 more cities next year, including Boston, Dallas, Minneapolis, Philadelphia, and San Diego, among others. The move is expected to help the company provide same-day pharmacy delivery to nearly half the U.S. by the end of next year.
For its part, Amazon said it was looking to capitalize on the growing number of "pharmacy deserts" that were being created by store closures. Walgreens told the Wall Street Journal that it plans to close a “significant” number of its roughly 8,600 stores in the United States. CVS, the largest US chain, closed 244 stores between 2018 and 2020. In 2021, it announced plans to close 900 stores. And Rite Aid filed for bankruptcy last year and will close up to 500 stores.
A Perpetual Short-Circuit
There is a perpetual short-circuit in the way of thinking about top-line innovation in healthcare. This is because operations (i.e., cost-cutting) is being confused for strategy at the highest levels, and because a small handful have the ‘agenda power’ and thus control the discussion and the production of better and bigger ideas.
What gets lost is this:
Healthcare is a ‘nested market’ where the whole system happens at once.
So entangled are the pathways within it and through it and around it and above it and below it that any analysis — no matter how intelligent and thoughtful, whether that’s Starboard’s “extensive 50-page slide deck” or the 36-page slide deck produced by Yale University School of Management as a counter analysis to Starboard’s analysis — will be wrong at the title slide.
It’s jumping-off point is illogical because it is fragmentary.
To wit Jeffrey Sonnenfeld and Steven Tian, the authors of the 36-page slide deck (‘What Critics of Pfizer and CEO Dr. Albert Bourla Are Missing’) last week:
Of course, what is undeniably true is that Pfizer’s stock price has gone sideways during Bourla’s tenure, to the understandable frustration of some shareholders. However, the underperformance of Pfizer stock isn’t all that it appears to be. In fact, Pfizer stock has performed in line with, if not a bit stronger than, pharmaceutical peers such as Merck, Johnson & Johnson, and Bristol-Myers Squibb this year.
Pharma stocks have been reduced to a “haves vs. have nots”: a stark divide between GLP-1-driven stocks, namely Novo Nordisk and Eli Lilly who have soared to record heights, and all other pharma companies, many of whom languish trading near record-low multiples as investor sentiment plummets. This is a reversal from the COVID-19 pandemic when those now-soaring stocks (Novo Nordisk and Eli Lilly) looked weak for having missed the COVID vaccine and therapeutics boom and were attacked by critics, while COVID-powered stocks benefitted.
To pin the blame for see-saw swings in the stock market on Bourla, considering Pfizer stock is performing exactly in line with non-Novo Nordisk, non-Eli Lilly pharma peers, one would have to fault Bourla for not developing a GLP-1 drug sooner, despite the fact virtually the entire pharmaceutical industry — like virtually every investor — was caught off guard by the speed with which these new obesity drugs were commercialized.
“PBM” and “retail pharmacy” are MIA in the deck. The words themselves are not in the content at all, nonexistent, having been assumed away as a kind of background radiation, underscoring one of those “untrue simplifications” sustaining the horseless carriage of healthcare — the belief that any one piece (market) can be isolated from its context and measured with precision.
The statistically machinery is powered to analyze and argue, in a sort of a cooperative equilibria. The players have become conditioned by each other’s behavior.
Put another way, the conversation Starboard is planning to have tomorrow with Pfizer leadership will hardly be a conversation at all. The conceptual model around which the agenda is based is fragmentary. It does not develop or evolve based on the drug market’s interaction with the retail pharmacy market.
It won’t snap things into a new orbit of competition and creativity.
Inventing a New Peer Group
In his book on the history of soccer tactics, Inverting the Pyramid, Jonathan Wilson writes that soccer "is not about the players, or at least not just about the players; it is about shape and about space, about the intelligent deployment of players, and their movement within that deployment.” Unlike chess, soccer is open.
The Standard Model of thought and action — the typical playbook — in health market strategy today prefers to treat the economics as a game of chess rather than a game of soccer. It reduces complex psychological and social phenomena to simple linear mathematical models, often without further justification or enquiry.
It focuses on the players, not about creating new space within which to deploy them.
Which is where Sonnenfeld and Tian started and landed with their analysis. Which is where Starboard started and landed with its analysis. Which is where Walgreen’s started and landed with its analysis. Which is the same cost-cutting frame being used to explore breaking apart CVS Health: presupposing the direction of casualty, confusing operations for strategy, performing a revisionist exercise to provide a semi-coherent interpretation of disconfirming facts.
The stuck market — whether that’s the collapsing retail pharmacy market or the collapsing Big PBM market or the drug market floating somewhere in between — will need different policy, economic and business constructs for what lies ahead, better ‘navigational knowledge’ to move faster than the current, to get in front of change rather than become a victim of it.
Assuming stability is one of the ways ruins get made
Humans rule Earth because we are supremely adaptive and resilient. Unlike other species struggling to adapt at ten thousand times normal evolutionary speed, we can achieve that tempo through technological advance. What is missing right now are the economic relationships and mechanisms necessary to mount such a multilateral effort at adaptation while ensuring universal access to its innovations.
“What’s changed is the world around us is now within us,” said Robert Cardillo, director of the National Geospatial-Intelligence Agency, during a Senate Intelligence Committee on a new context for military strategy. “What we used to hold exclusively — because we had capabilities that others didn’t — is now more shared.”
Cost-cutting is devouring industries. So is a fragmentary worldview.
The massive grapple is escaping Mckinseyland, to resist attempting ever more tortured reductionist accounts that lead to structural stalemate, an epidemic of arrested development and commercial withering across the board.
Should Walgreens even carry products? Should JNJ follow LillyDirect and become its own channel? Should JNJ or Eli Lilly or Pfizer acquire Walgreens for its ‘positional value’ as a care and service infrastructure? Can Big Pharma save Big PBM from strategic collapse? Does healthcare need “prior authorization”?
Walgreens, UnitedHealth Group and JNJ report earnings today. Starboard has its conversation with Pfizer tomorrow (Pfizer reports earnings on October 29). A modern strategy would see all of these as players as being on one team in a game that is screaming for a new shape.
If we want an atypical playbook, we should be asking different questions about how the players are deployed.
/ jgs
John G. Singer is Executive Director of Blue Spoon the global leader in positioning strategy at a system level. To engage with a mind stretch: john@bluespoonconsulting.com