I couldn’t help but notice how different a Walgreen Company (NYSE:WAG) advertisement I saw over the weekend looked. On the cover page of the company’s 16 pages of promotions was a message for Express Scripts Holding Company (NASDAQ:ESRX) members. The message stated Walgreens wanted Express Scripts customers back and these customers were eligible for a $25 Walgreen’s gift card if they switched a prescription to Walgreens. Another difference in this advertisement is Walgreen’s new loyalty program, Balanced Rewards. This loyalty program is similar to the program used by Duane Reade, a New York-based chain Walgreen acquired in 2010. Balanced Rewards gives customers points for prescriptions, immunizations, and front end sales, which can be redeemed for gift cards.
Walgreen’s lost its first fight this year against Express Scripts, when they realized that the largest pharmacy benefit management manager carried more weight than the largest retail prescription pharmacy. The temporary break-up, fueled by reimbursement rates between Express Scripts and Walgreen, sent 60 million Walgreen prescriptions to rival competitors. Walgreens went nearly seven months in 2012 without renegotiating a contract with Express Scripts (See how Express Scripts developed a sustainable competitive advantage). The impact of no longer having the largest pharmacy benefit manager (PBM) in their network caused Walgreens comp store sales to suffer. As Walgreens got further in to 2012, comp sales continued to decline, causing their third quarter sales to drop nearly 11%.
Now that Walgreen’s has come to a contractual agreement with Express Scripts, they will now face their second battle of the year, trying to recover the lost business from the Express Script dispute from competitors like CVS Caremark Corporation (NYSE:CVS) and Rite Aid Corporation (NYSE:RAD) (See why Express Scripts made the hedge funds top ten list). CVS has estimated that they will retain at least 50% of their newfound Walgreens customers.
At the Morgan Stanley Global Healthcare Conference, CVS stated that pharmacy clients are the hardest people to lose and the hardest people to get back, and CVS is doing everything in their power to retain Express Script clients. They believe that they have been able to effectively market directly to high value customers, and they have data that reflects their beliefs. Looking at the high value pharmacy customers that moved from Walgreen to CVS, 70% live within 2 miles of a CVS, and 55% have enrolled in their automatic refill prescription program. Although CVS is aiming to keep high value customers, those customers are also Walgreen’s biggest targets.
Competition for customers in this maturing industry is displayed by these retail pharmacies’ loyalty programs. CVS and Rite Aid are pulling out all the stops to keep the Express Script customers they retained from Walgreen, while Walgreen’s has rolled out their own loyalty program in hopes of replenishing lost Express Script customers (Click to see if CVS has reached its peak). CVS’s loyalty program is the clear leader in the retail drug industry. The company’s ExtraCare loyalty program is more than 15 years old and has 70 million active cardholders (defined as those who have used the card at least once the past six months). CVS does not view their loyalty program as a way of gaining new customers, but instead sees it as a way of locking in their customer base.
Rite Aid, meanwhile, signed up 52 million total members in less than two years after launching Wellness+, which debuted in April 2010. Rite Aid says it has roughly 25 million active members (defined as those that use their card at least twice the past 26 weeks) and those members accounted for 75% of front-end sales and 69% of prescriptions filled in the latest quarter. Rite Aid uses a tier system, in which customers can earn points to reach a certain level that qualifies for in-store discounts on Rite Aid branded products and if especially engaged, can result in a 20% discount on everything sold in the store.
We expect that Express Script clients that want to make the change aren’t going to wait, and Walgreens will have a better idea of how many customers they will get back by the end of the year. This should help Walgreen’s fourth quarter comp sales, but still isn’t expected to mitigate the damage in its entirety. CVS claims that Walgreen’s marketing strategy involving coupons will not help them retrieve their customers, as it has not worked for CVS in gaining new clients in the past. After being hit hard on Sept. 5, when the U.S. Defense Department’s Tricare health plan said Walgreens would not be in their network, it is more important than ever that the company recovers as many old customers as possible.
Disclosure: Mike is long Walgreen Company (WAG).