Express Scripts Holding Company (ESRX), Walgreen Company (WAG): This Stock Just Solidified Its Dominance

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Few things are certain in investing, but Express Scripts Holding Company (NASDAQ:ESRX)' dominance of the pharmacy benefit manager (PBM) market is virtually assured after its $29 billion acquisition of Medco last year. As a result of the acquisition, Express Scripts now has more than 100 million members and controls one-third of U.S. pharmaceutical spending.

Express Scripts (ESRX)Bargaining power

The company's year-long squabble with Walgreen Company (NYSE:WAG) is a prime example of its bargaining power as the largest PBM in the United States.

When Walgreen did not immediately agree to price cuts, the drug store chain was cut out of Express Scripts Holding Company (NASDAQ:ESRX)' network. As a result, Walgreen lost $4 billion in revenue, while Express Scripts hardly suffered. What's more, the damage to Walgreen is probably permanent, as its old Express Scripts customers now use different pharmacies; Walgreen will have to give them a reason to switch back.

If Express Scripts can push around Walgreen -- the nation's largest drugstore chain -- then it certainly has significant bargaining power. In fact, PBMs' bargaining power will only continue to grow as the industry consolidates -- putting retail pharmacy chains like Walgreen at a growing disadvantage. And, as the largest and most powerful company in the industry, Express Scripts will reap most of the rewards at drugstores' detriment.

Competition looking for the exits

Smaller competitors like Wellpoint and Aetna are trying to exit the PBM business -- as attempts to compete with Express Scripts Holding Company (NASDAQ:ESRX) are futile.

However, CVS Caremark Corporation (NYSE:CVS) has made a strong commitment to its integrated offering that includes clinical services and a retail pharmacy in addition to pharmacy benefit management. Management had hoped that the company could cross-sell customers on its own services and gain more control over its own costs. It could compete with Express Scripts by building its own complete ecosystem that no other PBM could penetrate.

However, the strategy as not worked out as well as planned. Although revenue has increased, the planned cost savings have never shown through and margins have fallen for CVS' PBM business.

In addition, CVS is subject to the same pricing pressure from PBMs that has eroded Walgreen Company (NYSE:WAG)'s moat. Namely, if CVS wants to keep traffic flowing from customers using other PBMs, then it must submit to the price pressure from the increasingly-powerful companies.

As a result, the outlook for CVS is no different than that of Walgreen Company (NYSE:WAG): it will eventually cede all power to PBMs.

It's good to be a PBM

With that said, it is not so bad if you are the largest PBM in the U.S. Express Scripts Holding Company (NASDAQ:ESRX)' enormous scale not only affords it greater bargaining power, it also allows it to offer a better value proposition to its customers due to its ability to lower prices.

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