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January 10, 2005

A new prescription | After closing six of its drug stores, Augusta-based Community Pharmacies eyes a different retail model for growth

By Sean Donahue
For a company founded as an alternative to the big, national drug store chains, Community Pharmacies' sale of five of its locations to Rite Aid in December was a particularly difficult end to what CEO Joe Bruno admits was a frustrating year. The biggest issue facing Community Pharmacies ˆ— and other pharmacies in Maine ˆ— in 2004 was the state's January decision to cut the reimbursement rate it pays pharmacists to fill prescriptions for Medicaid patients. Those cuts forced Community Pharmacies to reduce hours and staffing levels at some stores, Bruno says, and made it too difficult to make a profit at the five pharmacies, primarily in northern Maine, the company ultimately turned over to Rite Aid. (The company also shut down its Scarborough location.)

Despite that disappointment, though, Bruno says selling the unprofitable stores actually helped the Augusta-based chain ˆ— which still operates eight locations and employs 110 people ˆ— focus on a new growth strategy for the future. Instead of building stand-alone drug stores, the company plans to establish new Community Pharmacy locations inside independent grocery stores across Maine. "We're going to continue with our basic philosophy of finding the best pharmacists we can in an area," says Bruno. "We're just looking at opening much smaller stores."

For Community Pharmacies, smaller stores mean less inventory, fewer staff and lower costs. Those savings, in turn, help the company deal with a thin net margin on prescriptions, which Bruno and other pharmacists say hovers at about one percent. The store-within-a-store approach also gives independent grocers, who are feeling pressure of their own from larger chains, a way to match the full-service stores offered by those large competitors.

It's a strategy that's been reshaping the pharmacy market around the country. Though traditional drug stores still dominate, their numbers are declining while the number of supermarket locations is growing. Between 1995 and 2003, the number of pharmacies inside supermarkets grew 56%, to 9,427, while the number of stand-alone drug stores declined 4.1%, to 55,382, according to the National Association of Chain Drug Stores.

Putting pharmacies inside grocery stores "has certainly been proven on the chain level," says Neil Stern, a partner at Chicago-based retail consulting firm McMillan/Doolittle. "In fact, pharmacies are one of the few growth areas that large grocery stores have."

Now, Community Pharmacies is hoping to recreate that success by developing a local, independent version of the grocery-pharmacy partnership.

The volume equation

Community Pharmacies actually got its start thanks to another transaction with Rite Aid back in 1998 ˆ— but then as the buyer, not the seller. At the time, the state ordered Rite Aid to divest itself of a store in Dover-Foxcroft following the company's acquisition of Brooks pharmacies in Maine. Falmouth entrepreneur Bill Waldron, who owned the prescription claims processing company GHS Data Management (see "An eye on Iowa," at left), saw an opportunity not only to buy the location but also to create a new pharmacy chain in the state.

Waldron and his partners, Bruno and John Grotton (now CEO of GHS Data Management), sought out experienced pharmacists who wanted to open their own stores in smaller towns and rural areas of the state. Each of those pharmacists became part owners of the company, which handled the accounting, billing and other regulatory-related paperwork that typically makes it hard for independent pharmacists to focus on customers, says Bruno. In addition, pooling orders among multiple locations generated savings on wholesale drug purchases and other inventory.

Community Pharmacies grew quickly under that model, opening seven stores in two years and reaching 15 locations ˆ— and almost 200 employees ˆ— in 2002. Then, says Bruno, a series of cuts to Medicaid reimbursements began making it harder for Community Pharmacies to serve areas with a large number of Medicaid patients profitably.

In particular, the state's decision a year ago to cut reimbursement from 87% to 85% of a prescription's costs eats into the 15% to 18% discount on wholesale drug prices Community Pharmacies typically receives from its suppliers, says Bruno. For example, Community Pharmacies may pay $85 dollars wholesale for a prescription it fills for $100, but with the state only reimbursing 85% of that cost it still wouldn't make a profit on the sale. At the same time, the $2.35 dispensing fee the state pays pharmacists for each prescription they fill doesn't cover store overhead and the cost of employing pharmacists, says Bruno. "The only way to make money in the pharmacy business is on volume," says Bruno. "If you can't fill 1,000 to 1,200 prescriptions a week, it makes it awfully hard to make a profit."

(Responding to questions about the reimbursement reduction, Jude Walsh, prescription affairs coordinator for the Governor's Office of Health Policy and Finance, says that even the reduced Medicaid reimbursement rate is consistent with, or in some cases better than, the rate offered by commercial insurance plans. But recognizing that rural pharmacies can be at a disadvantage to large chains when negotiating drug discounts, the state recently implemented a $2.1 million rural pharmacy incentive to subsidize pharmacies that meet certain criteria, such as the number of Medicaid customers served, compliance with preferred drug lists and distance from other pharmacies. One hundred and seventy one pharmacies qualified for the program, and the first payments went out at the end of December.)

The combination of low volume and low reimbursement rates led to Community Pharmacies' decision to close its locations in Fairfield, Fort Kent, Gray, Houlton and Madawaska, and sell those stores' prescription lists to Rite-Aid (Community Pharmacies also closed its Scarborough store, but did not sell that store's prescription list). But even large chains like Rite Aid say they've struggled to handle cuts in MaineCare reimbursement rates, with Rite Aid reducing pharmacy hours at some Maine locations earlier this year.
Still, the company says purchasing Community Pharmacies' prescription files makes sense, since it will increase volume at existing stores. "We're able to add to our customer base without adding a lot of overhead to our current business," says Jody Cook, a Rite Aid spokeswoman. "We're already paying for leases and paying utility bills on our locations there."

With the entire pharmacy industry focused on boosting volume while keeping overhead low, Community Pharmacies set out to find its own profitable store model. The solution, it believes, is inside existing grocery stores.

Sharing shoppers

Establishing pharmacies inside grocery stores isn't a new technique for Community Pharmacies. In fact, the company's second location was a pharmacy inside Goggins IGA in Randolph, opened in 1998. Since then, Community Pharmacies has opened two other grocery-store locations: one at Bud's Shop 'n Save in Dexter in 2001 and another at Trade Winds Market in Corinth in 2003. The lessons learned from those locations ˆ— particularly the advantages they have over stand-alone stores ˆ— helped Community Pharmacies decide that the model offered the company its chance for growth in 2005 and beyond, says Bruno.

For starters, the typical Community Pharmacy in a grocery store needs 400 to 600 sq. ft., versus the typical 4,000 to 6,000 sq. ft. needed for a stand-alone store ˆ— meaning lower costs for rent, utilities and taxes. And since the grocery store already carries the over-the-counter medications, bath and beauty products and other sundries typically found in a drug store, Community Pharmacies can save $200,000-$300,000 in inventory costs a year, says Bruno.

The other big advantage grocery stores offer is built-in traffic, which helps increase prescription volume while reducing the amount of money the pharmacy must spend on advertising. "Our pharmacies can become profitable in a year and a half when they're in a grocery store, versus the three to four years it takes in a stand-alone model," says Bruno.
Grocery stores also benefit from the relationship, say analysts. In particular, partnering with an existing pharmacy is a much faster way for grocery stores to develop their own prescription business, since the pharmacy usually has a pre-existing list of customers. Those pharmacy customers offer a potential traffic boost for the grocery store, too, if they do some shopping while waiting for their prescriptions.

The scenario has played out nicely for Dean Homstead, owner of Bud's Shop 'n Save in Dexter, who added a 450-square-foot Community Pharmacy to his store in 2001. Having an on-site pharmacy, he says, helps his store keep pace with services offered by larger grocery chains ˆ— which in turn helps him retain customers. "The more you can offer the customer, the more convenient you make it for them, the more one-stop shopping you provide, the happier they are," says Homstead.

Now, as Community Pharmacies looks to increase its partnerships with independent grocery stores, Bruno says the company is examining two potential locations it hopes to open in the next six months. But picking partners and locations can be tricky, says Stern of McMillan/Doolittle, since both small pharmacies and independent grocery stores face intense competition from larger, better capitalized chains. "There will continue to be independent grocery stores and independent pharmacies, but there's also going to be a lot of those guys closing down" because of competition, says Stern. "From that standpoint, you have to choose your partners wisely."

Bruno acknowledges that picking the right locations will be crucial to the success of Community Pharmacies' growth strategy. To that end, he says the company carefully researches potential grocery partners to make sure their traffic and sales are strong. The research also helps Community Pharmacies ensure that the two companies have similar operating practices and customer service philosophies, since smaller stores have to rely on better customer service or a more knowledgeable staff when they can't beat larger chains on price.

In that way, developing pharmacies inside grocery stores allows Community Pharmacies to stick to its founding philosophy of using hometown pharmacists to create a local alternative to big chains, says Bruno. But even as he sees the approach as a means to keep the company growing, he doubts the combination will allow Community Pharmacies to return to the northern Maine towns it gave up last year. "I think our concentration is going to be from Bangor south," says Bruno, "but we're still looking at rural communities because that's where we thrive."

An eye on Iowa

A few days before Christmas, GHS Data Management executives John Grotton and Jim Clair were on a plane to Des Moines, Iowa. It was the pair's second visit in as many weeks to the Hawkeye state, and even though the timing wasn't ideal, Grotton and Clair were happy to make the trip in order to close their company's first big, out-of-state contract: Starting in July, GHS will electronically process all prescription drug claims for Iowa's Medicaid program ˆ— a $12 million to $14 million, five-and-a-half-year contract that contains options for three one-year renewals.

Once a sister company to Community Pharmacies under The Waldron Group of companies, Augusta-based GHS Data Management in August split off from the pharmacy chain and was given its own management team expressly to focus on expanding its Medicaid claims processing business. For 30 years, GHS has handled Medicaid prescription processing in Maine, starting with paper forms and then developing an electronic system.

Now, the company is trying to take that system, as well as its expertise, and offer similar services across the country. "There's so much work to do here we had to devote ourselves to this one company," says Clair, who formerly served as a vice president of Community Pharmacies and is now COO of GHS Data Management.

Though GHS Data Management offers an array of medical and data entry services, the 150-employee company's specialty, says Clair, remains helping states manage their Medicaid prescription businesses. To do that, GHS acts as an information clearinghouse. In Maine, for example, it collects Medicaid eligibility information from the state and stores it in databases that are connected to every pharmacy in Maine. When customers come for their prescriptions, pharmacists log onto GHS's database and check their eligibility. Later, GHS helps the pharmacies get paid by submitting claims to the Medicaid Management Information System.

Prescription claims processing is just one of several services GHS provides for Maine's Medicaid program, along with developing and maintaining a preferred drug list, negotiating supplemental rebates from drug manufacturers and other general support ˆ— a contract worth about $6 million for the fiscal year ending in June. Those are tasks the state has delegated to help save money on the 8.5 million prescription claims it handles every year. "Because claims processing requires constant management, it doesn't make as much sense to take it on in-house," says Jude Walsh, pharmacy affairs coordinator with the Governor's Office of Health Policy and Finance.

Now, GHS is hoping to provide a similar service to Iowa and its 300,000 Medicaid patients. After answering Iowa's request for proposals last July, GHS won a contract to help the state develop a preferred drug list. By the end of the year, the company had negotiated to take over the pharmacy claims processing business as well, and expects to handle about five million claims a year. On top of the Iowa deal, GHS currently is negotiating with the state of Washington to handle its Medicaid prescription claims processing.

Looking ahead, GHS CEO John Grotton expects the demand for third-party service providers to grow, particularly as states adopt a new Medicaid Part D program in 2006 that will move certain patients out of Medicaid and into Medicare. "This is going to be a huge change nationally," says Grotton, "but in that lies the opportunity for companies to help states make sure the transition is smooth."

Still, Clair and Grotton admit they face "fierce" competition from much bigger companies, such as Virginia-based First Health Services Corp, which provides pharmacy management programs in 17 states. That's why deals like the Iowa contract are important for GHS. "We've lost some bids before, when competing for work in Texas. They said, 'We just don't think you're quite big enough to handle the state of Texas,'" says Clair. "Maybe they're right, but I think states like Maine and Iowa are good fits for us."

Community Pharmacies LP

79 Leighton Rd., Augusta

Founded: 1998

CEO: Joe Bruno

Employees: 110

Service: Chain of pharmacist-owned drug stores and pharmacy counters inside independent grocery stores

Revenues: Did not disclose

Contact: 800-730-4840

www.communityrx.com

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