Amazon.com Inc. (AMZN, Financial) has tackled a vast array of challenges as it pushes into an ever-increasing number of industries. It has already transformed (one might even say conquered) the consumer retail space through its e-commerce juggernaut. The acquisition of Whole Foods has set the company on a path to tackle the grocery market in similar fashion. Now Amazon is set on the path of disrupting another big industry: pharmacies.
A lot has been written already about Amazon’s first steps into the health care arena. In this research note, we add to that growing library of commentary and analysis with a discussion of the company’s new strengths that can help it succeed where other disruptors (including Amazon itself years ago) have failed.
Second time’s the charm
Setting aside all the fanfare and speculation surrounding Amazon’s emerging health care strategy, it is important to remember this is actually not the first time the e-commerce giant has attempted to push into the health care market.
In 1999, Amazon made a play in the pharmacy space with a big investment in Drugstore.com. A morass of regulations and red tape, as well as concerted industry pushback, put paid to Amazon’s ambitions. It scrapped the Drugstore.com project in 2000.
Today, Amazon is back. The company is far larger than it was in 2000 and has access to far more financial firepower and lobbying muscle. It has also helped to usher in a new era of e-commerce across the board. Today’s consumers do far more shopping online and internet penetration is far more complete. At the start of the new millennium, the online economy was still in its nascent stages. In 2018, it is in full flower. Amazon has the resources and will it lacked last time, and the market is far more receptive.
Chapter two of Amazon’s health care push is already looking much better than the first. The recent acquisition of online pharmacy PillPack for close to $1 billion represents a huge first investment. It is just the opening shot in a whole new game.
Playing with new advantages
While any entry into a wholly new sector is fraught with difficulties, Amazon has the benefit of new advantages it lacked during its last abortive attempt to break into the pharmacy sector.
Amazon's greatest resource is scale, as a recent CB Insights report points out:
"Its current scale and reach are larger than ever before. The company has a direct distribution advantage to over 300M active customers, 100M Prime Members, and approximately 5M sellers on the site, which could prove useful should it ever develop health solutions for small businesses."
Amazon has access to a customer base of unrivaled scale and some of the best and deepest distribution channels in the world. That is a huge advantage in the pharmacy sector.
Scale is not the only advantage Amazon has this time around. It also has a couple heavy-hitting partners to help it succeed. Specifically, it has formally teamed up with Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) and JPMorgan (JPM, Financial). Berkshire’s Warren Buffett (Trades, Portfolio) already made an ambitious bet on generic pharmaceuticals giant Teva (TEVA, Financial), so a partnership with Amazon to tackle the lucrative pharmacy sector makes a fair amount of sense. With Berkshire and JPMorgan, Amazon has forged a potentially powerful triumvirate, as the aforementioned CB Insights report makes clear:
"By teaming up with JPMorgan and Berkshire Hathaway, Amazon now has an additional pool of more than 1.2M employees — diverse in socioeconomic status, geography, and age, among other factors — to test its products on before releasing them to the public.
This could be helpful when searching for solutions that work for both specific use cases (e.g. chronic disease management) and population demands (e.g. pharmaceutical delivery)."
Incumbents aren’t sweating
Despite its clear advantages, strengths and resources, Amazon is not going to take on the established pharmacy sector without a big fight. Walgreens (WBA, Financial) and CVS (CVS, Financial) have their own substantial online, as well as brick-and-mortar, presence, which Amazon will likely find difficult to dislodge. With no flesh-and-blood pharmacists and pharmacy locations, Amazon may even find itself at a disadvantage were it to try to replicate the offerings of incumbent companies.
Overall, the market is so vast that Amazon may not even register on the radars of the big pharmacy companies, even if it makes headway into the space. GuruFocus contributor Vitaliy Katsenelson addressed this point very effectively in a recent article:
"Americans currently spend $450 billion a year on drugs. Walmart is the fourth-largest pharmacy in the U.S., with sales of $21 billion, or 4.6% of the company’s total sales. Let’s say that over the next five years Amazon gets to Walmart’s sales level of $21 billion. If the U.S. pharmaceutical industry grows 2% a year over that time, total drug sales will have increased by $45 billion, or the equivalent of two Walmarts (we are ignoring compounding here), to $495 billion. Walgreens, with its pharmacy selling about $70 billion a year, would barely notice Amazon’s presence.
I’ve made this point before, but it is important to repeat: 10 years ago Amazon was not taken too seriously. Giants like Google, now Alphabet, and Microsoft ignored Amazon’s entry into cloud hosting, thinking, “What does a bookseller know about the cloud?” They have regretted it ever since.
Nowadays everyone is taking Amazon too seriously, bestowing CEO Jeff Bezos with walk-on-water-like superpowers. Boardrooms today are filled to overflowing with chatter about Amazon. There‘s admittedly a lot Corporate America can learn from Bezos (for instance, about ignoring short-term results), but Bezos is not superhuman and Amazon cannot bend the laws of economic gravity."
This is an important reality check. While Amazon has been massively successful in disrupting numerous sectors through e-commerce and cutting-edge distribution channels, it is not likely to overturn the pharmacy sector wholesale in the same fashion it did traditional booksellers and retailers. CEO Jeff Bezos has a clear vision and a track record of delivering big on his promises, but the economics of the pharmacy space make it highly unlikely Amazon can pummel incumbent players into submission.
Verdict
When Amazon began flirting with the idea of entering the health care sector, much of the discussion focused on the generics vertical. It has fewer barriers to entry than branded pharmaceuticals and makes money through volume rather than high-priced patented prescription medications. That sounds like exactly the sort of business Amazon is good at tackling.
There is a lot of value in the pharmacy space, and Amazon looks like it will succeed in capturing a share of it. But investors should not be banking on outright conquest.
Disclosure: I/We own no stocks discussed in this article.
