Pharmacy giant CVS recently announced that it would no longer sell tobacco products.
CEO Larry Merlo explained the decision in a statement, noting “Ending the sale of cigarettes and tobacco products at CVS/pharmacy is the right thing for us to do for our customers and our company to help people on their path to better health. Put simply, the sale of tobacco products is inconsistent with our purpose.”
On the surface the decision makes a lot of sense. CVS wants to become a leader in healthcare and selling tobacco products doesn’t align with this goal.
The announcement also generated a lot of positive publicity for CVS.
As a business decision, however, I find it very puzzling.
One thing seems clear: this is an expensive move. CVS sells more than $1.5 billion of tobacco products a year. While this is a small portion of the company’s total revenue, perhaps 2%, it is still a sizable business. If CVS makes a 30% margin on tobacco products, a fairly standard retail margin, the move has a cost of $450 million annually. In 2013 CVS had pre-tax profits of $7.5 billion, so a $450 million hit is meaningful.
The financial cost is clear. What is less clear is how this decision will lead to incremental sales.
Will people rush to CVS now that the company doesn’t sell tobacco? I suspect not. Most people choose a pharmacy based on convenience, service, price and insurance coverage.
Will people buy more at CVS when they visit? No.
Can CVS raise prices? No.
Will the move reduce operating costs? No.
So how in the world is it a good business decision?
The argument that tobacco isn’t a healthy product so CVS is dropping the category as a matter of principle just doesn’t make sense. Soda isn’t good for people, either, or alcohol or lottery tickets or Twinkies. CVS sells many things that aren’t good for people.
Some people argue that hospitals don’t sell cigarettes so CVS shouldn’t sell them, either. This argument doesn’t work. CVS isn’t a hospital. It is a pharmacy and a retailer.
CVS provides patient case under its Minute Clinic brand. Minute Clinic clearly shouldn’t sell tobacco or soda or lottery tickets. It also shouldn’t sell carrots or lettuce. Minute Clinic provides healthcare services. CVS sells products.
There must be more to this than meets the eye. Perhaps margins on tobacco products are so small that there actually isn’t a financial hit. Perhaps public interest groups pressured CVS to make the announcement. Perhaps CVS needs to bolster its credentials in a negotiation with government payers.
Otherwise it is just a bad business decision.
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Interesting juxtaposition: “…just a bad business decision.” followed by a pitch to buy your book “Defending Your Brand”. Seems to me that’s exactly what they’re doing. Tobacco is inconsistent with the image, and by extension future value, they hope to achieve for the ‘CVS’ brand. Besides, as others have pointed out, that shelf space will not go empty.
Maybe an odd move by “CVS,” but not an odd move for “CVS/Caremark.” Think about their PBM (e.g. negotiating with government payors). Also, gross margins aren’t 30%.
Everyone is fixated on the immediate value of the lost sales, but there are a raft of reasons that collectively make this a smart long-term decision.
The market for tobacco is shrinking.
The margin is 15%-ish, much lower than many drugstore items – this shelf space gets repurposed, it doesn’t disappear.
Depending on what you’re measuring, the regulatory issues, age enforcement, theft, slowing of the checkout line and other related costs exceed the benefit – this is why Target stopped almost 20 years ago.
Most cigarettes (over 85%) are sold at convenience stores, so they’re losing very little on peripheral items sold to smokers along with their cigarettes.
It’s a great PR move and fits with their overall strategy towards delivering health (though they still have a ways to go).
Based on the amount of media and social media activity, it was a strong offensive move by the #2 player in the industry. We’ll see if/how Walgreens responds and defends their brand.
David—Excellent points. It could be that the move wasn’t much of a financial loss. In that case it is all upside for CVS.
It is interesting that Walgreen’s hasn’t matched the move yet. Perhaps Walgreen’s is waiting to see precisely how it impacts store traffic. The move might actually be a positive for Walgreen’s; people who don’t smoke aren’t likely to switch to CVS and people who do smoke may switch to Walgreen’s.
Tim
It could also be a CSR consideration. Soda, alcohol, lottery tickets and twinkles are not appropriate analogy since none of them are purely harmful as cigarettes. This gesture might impact the revenue in the short run but time will tell in the long run.
Eric–I agree this will be an interesting one to watch! It could be part of a long-term strategy that will take shape in the coming years.
Tim
Good business decision don’t always need to be quantitative if the qualitative rationale is consistent with a strategic intent. I believe this to be the case at CVS and only time will tell if this tactical decision supports it longer-term growth goals.
I believe, the local and state tax is so high it is not worth it. They most likely pay more to the employees who stock the shelves and sell them then they recieve profit. So dropping that business adds to the good will and would not cost as might as a new campaign. They received national press from Bob Shieffer. https://www.cbsnews.com/news/bob-schieffer-on-cvs-and-cigarettes/
Barb—I would love to see the financials on cigarette retailing. It could be so low margin that it isn’t much of a loss for CVS.
Tim
On a pure mathematical point of view, if their KPI is profit per sqft, dropping potentially low margin products make sense if you have better margin products to replace with (wince sqft remains constant).
Could that be they are trying to evolve to a hipsters kind of place? Moving up in their offering to organic food for instance? kind of wholefood-like. Monoprix in France did a good job with this (they are not a pharmacy though – different legal environment). They have plenty of very good locations in center cities that they may be able to leverage … Just a thought.