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Drug Store.com

E-retailing-the first year

The pure online drug store--a little more than a year after its heralded and well-financed debut--isn't what it used to be. In many ways, it's a lot more. That's more, of course, as in more of them, with some analysts estimating that there now are more than 260 Internet sites selling prescription drugs. (This doesn't even consider the number of sites for such specialty products as personal care, vitamins and OTCs.)

But e-retailing for drug stores also is more information driven and healthcare conscious than likely was imagined a year ago. It's also more competitive in terms of capturing customers and links with pharmacy benefit providers and--perhaps the biggest change--online drug stores are a lot more closely tied to the brick-and-mortar world than was predicted.

Indeed, one of the first online drug stores, soma.com, was gobbled up by CVS last May. In a way that deal signaled a recognition among the e-retailers that to be truly successful, the Internet drug stores would have to forge some kind of partnership with either a traditional drug chain or a PBM.

At the same time, the combination of CVS and soma.com, which has been renamed CVS.com, pushed other brick-and-mortar chains to become more diligent in their efforts to get online with an e-commerce and healthcare offering. Just a few weeks after CVS's soma.com acquisition, Rite Aid announced a far-reaching alliance and an equity investment in drugstore.com, the most visible and strongest financially supported of all the early e-retail players. Those two deals also intensified the competition for online sales--for both the traditional chains and the pure e-retail players.

"The biggest change in e-commerce in the past year is the cost of customer acquisition," said David Kriegel, chairman and chief executive of Drug Emporium, the first traditional drug chain to establish an online drug store with www.DrugEmporium.com. "They have raised the bar on the cost of acquisition, on a per customer basis. That is a lot of wasted money and effort."

New rules

While the bar has gotten higher, the nature of the game has changed, too. Almost all the entire major Internet players have tried to forge relationships with PBMs, wholesalers or traditional brick-and-mortar chains.

"The problem with [the first] online drug stores was that none of the concepts were based on studying what consumers really need in their life and then trying to meet it," said James Tenser, principal retail strategist with Nexgenix, an e-business consulting firm. "They were based on trying to create an analog to the existing store [on the Web] and then making compromises because there were limitations with the online delivery.

"So the thought process typically went, 'I see there is a retail channel out there. Let's try to create an online analog and be the first in and beat the market.' That's what happened with online drug stores," Tenser said. "But none of these companies considered at start-up time that there would be such a barrier in terms of the prescription drug plans. They didn't even understand their own market."

The restrictions imposed on e-retailers by PBMs are often "a pain in the neck," and serve to lock out many online drug stores from a sizable portion of the prescription businesss, said Claudine Singer, a senior analyst at Jupiter Communications in New York. "Consumers want value and convenience," she said, noting that in some ways it's still easier for consumers to purchase prescriptions off-line.

"While it is a market that potentially could provide significant benefits to the consumer, right now there are enough hurdles for consumers to get past that we're not seeing them shift their health-related shopping behavior [to online]," she added. Still, Singer said she has strong expectations for online drug stores to increase their share in the future--once they get past some thorny barriers, including the insurance issues, delivery lags and the problem of handling merchandise returns.

"On a comparative basis, certainly the brick-and-mortar stores are at more of an advantage," she added. "The players who have online as a complementary channel to their brick-and-mortar operations and those that have a brand already established and fixed in consumers' minds are relatively advantaged compared to the upstarts."

Singer said she believes there absolutely is a market for online health commerce. "And by the way, I don't think the market is fully landscaped yet. Some of the key players have yet to make their mark," namely Wal-Mart and Walgreens, she added.

Even as the e-retail sector has been transformed, however, it has not diminished the opportunities that are out there in cyberspace.

"Online drug retailers can capture 5 percent of the total drug store industry by 2004, [which represents] a $20 billion opportunity," said Deborah Weinswig, a securities analyst at Bear Stearns. "It is one of the fastest-growing categories in cyberspace."

But that effort to tap the Internet market and capture customers has taken a financial toll. Two of the e-retailers to issue shares to the public-drug-store.com and PlanetRx.com--are still far from profitability and, at this point, losses are still outpacing sales by a wide margin. Even CVS.com, which the CVS parent acquired for $30 million, is not forecasting profitability for another two years as it works to refine the various aspects of Internet retailing with health care.

More than e-retailing

Kriegel said DrugEmporium.com was "not going to chase that bait" by focusing solely on customer acquisition. "If you believe heavily that the fundamental play here is business-to-business and not business-to-consumer, then you have to recognize that you must spend some money toward B-to-B. But your primary interest has to be on building the infrastructure and the cost of the infrastructure on the B-to-B opportunity. That is where DrugEmporium.com will differentiate itself from the rest of the players."

Other drug chains with on-line businesses are taking similar tacks and not focusing too heavily on the e-commerce component of the Internet. Walgreens, for example, has yet to launch a front-store offering at its Web site, but the chain has lined up several deals with healthcare providers, such as the Mayo Clinic. The chain also is handling thousands of prescriptions each day at its Web site.

"There is far more potential for us to fill a significant need--as well as make a profit--by sending information over the Internet than aspirin through the mail," David Bernauer, Walgreens president and chief operating officer, said at a recent financial conference in New York. "The more consumers who ... give you personal information, the stronger your relationship becomes, of course. That's what we will concentrate on."

Bernauer said Walgreens believes that improved patient information will have a significant impact on the quality of health care over the next decade. "It's our intention to be at the heart of that revolution, primarily through leveraging the power of the Internet and the potential of our site," he added.

With such strong growth projections for the Internet, traditional chains had to take notice, said Jonathan Ziegler, an analyst at Deutsche Bank/Alex Brown. "They started out defensively--because they didn't want the independent e-commerce companies to take business from them--and now they are finding out the Internet also can be an offensive or brand-building measure that can be very powerful," he added.

"We think the Internet is something that will grow and that the Internet will help us build a relationship with our customers that will be the most powerful and the most loyalty-building thing we have done to date."

Disease-specific dot-coms

The health care part of the online drug store equation has not gone unnoticed by the pure e-retailers, either. PlanetRx.com, for example, has acquired or established 29 health-related Internet sites, including allergy.com, arthritis.com and diabetes.com. The e-retailer is working with pharmaceutical companies to develop these sites and expects that their sponsorship revenues will be a significant contributor to the company's top-line sales in the future--up to as much as 15 percent of total revenues.

In the future, there could be further convergence of the online channels, according to Tenser, who predicted that the online concepts of the future will not be analogous to the retail channels known today. Instead, the online retailing will focus more on a "home-replenishment kind of concept that combines drug store and personal-care type merchandise, including prescriptions, with items such as groceries and household consumables," he said.

"The Web isn't necessarily a place to create analogs of the business processes that we already know in the traditional world," he added. "You have to create processes that are optimized for the Web, and you have to create consumer propositions that are optimized for the Web. In the future, I see the online drug store business having as its biggest competition the household-replenishment-type online retailers, or what we roughly call today the online grocers."

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