CVS Cigarette Decision Is a Daring Bet on the Future
Business + Economy

CVS Cigarette Decision Is a Daring Bet on the Future

REUTERS/Carlo Allegri

Cynics are busily pointing out that the decision by CVS Caremark (NYSE: CVS) to yank cigarettes and other tobacco products from its shelves isn’t an altruistic one, but a ploy to capture a bigger stream of long-term revenue from its pharmacy and health care business.

They’re also lining up to point out that CVS will still be selling sugary foods and drinks that contribute to the country’s obesity problem as well as items like lottery tickets that aren’t good for our finances and celebrity magazines that probably are another complete waste of money. All of these are valid points, but they’re not what I see as interesting about the CVS initiative.

Decade after decade, it seems, we’ve been treated to an array of corporations relentlessly pursuing profits, doing whatever they are legally able to do (and sometimes crossing that line, too) in the name of serving their shareholders by delivering an extra few pennies or dollars of profits at the end of each quarter.

Only when that quest clashes too dramatically with the broader public interest – as in the financial crisis of 2008 or the offshore oil drilling disaster in the Gulf of Mexico, to name only two instances – do we pause to ponder a message that by now should be clear. Just because we can do something, doesn’t mean that we should do it. 

Related: Why Smoking Is Even Worse Than We Thought

It’s rare for a corporation to cut off a possible source of profits simply because there’s a chance that something might go wrong down the road. Historically, they have found it more prudent to stand by and wait for someone else to tell them that they’re not allowed to do something, whether it’s operate a proprietary trading desk on Wall Street, sell jumbo-sized sugary soft drinks (as in the case of former New York Mayor Mike Bloomberg’s failed attempt at a ban) or sell cigarettes.

In this case, the prudent route might have been to continue “studying” the idea, as other drugstore chains are doing and wait for more big cities to follow the lead set by Boston and San Francisco and ban drug store sales of tobacco products.

Instead, CVS has opted to roll the dice. Its upfront loss is clear: The company will forfeit some $2 billion in revenue from cigarettes, cigars, tobacco and other products.

By some measures, that’s a drop in the bucket: For the full year 2012, the retailer’s revenues topped $120 billion. But it’s not a stream of income on which any CEO can lightly turn his back. Especially when, in many cities, a customer can simply walk a block or two further to reach a Walgreen’s or RiteAid store and not only stock up on cigarettes but do the rest of his shopping – including prescriptions – at the same time. CVS, in the short term, stands to lose much more than $2 billion in revenue. It’s also likely to forfeit market share to its larger rival, Walgreen’s.

It’s now up to CVS CEO Larry Merlo, himself a former pharmacist, to prove that the gamble will pay off in the former of greater customer loyalty and above-average growth rates in both revenues and profitability.

It should work. First of all, the announcement has already given the brand something of a boost, and a marketing lift. Even President Obama publicly applauded the move. The decision also means there will be less cognitive dissonance between CVS’s push to transform itself into something of a health care company, providing frontline services ranging from flu shots to primary care clinics under the umbrella of its pharmacies.

Consumers are skeptical at the best of times, and hyper-vigilant when it comes to someone trying to extract money from them in the name of health in one corner of the store, while (wink, wink; nudge, nudge) enabling their bad habits like smoking elsewhere. Assuming that CVS is able to provide a health care product that customers value, and that prices on its other products remain competitive and its stores are conveniently located, this should pay off for those Americans who aren’t smokers.

What it all boils down to, for me, at least, is that investors may want to start viewing CVS similar to how they see Amazon. No, I’m not arguing that CVS has overnight earned a price/earnings multiple that’s in nosebleed territory. Rather, I’m suggesting that if we’re patient with Amazon – giving Jeff Bezos enough rope when it comes to new warehouses, new content delivery technologies and yes, even that overhyped Amazon drone – CVS has earned the right to the same degree of benefit of the doubt.

True, we’ve long been accustomed to Amazon challenging conventional wisdom on all fronts and to the idea that its management will plough every dollar of profits back into the company in the name of future growth. The idea that an old-style drugstore retailer like CVS might take a similar approach is somewhat more novel and provocative. Nonetheless, that’s really what is happening here. CVS has made a calculated and strategic decision to forego delivering current profits to its investors in the interests of developing a long-term business opportunity that it believes will be far better and more sustainable.

Admittedly, it’s not a direct comparison. Amazon, for instance, hasn’t decided that it will focus only on digital content and refrain from selling, say, garden tools or children’s toys.  But CVS had already signaled its intent to invest in developing its pharmacy benefit management system, providing prescription management to healthcare plans. That investment is paying off: In the third quarter, revenue from the PBM management division hit $19.5 billion, up nearly 8 percent. In a related move late last year, CVS paid $2.1 billion to snap up Coram LLC, a specialty pharma business that it believes will bolster that PBM group’s bottom line as profit margins on generic drugs dwindle.

CVS has chosen to be proactive in addressing what it sees as both opportunities and risks to its business. It’s willing to run its own set of risks, alienating some groups of both investors and customers. I, for one, hope the former will understand that this is just the first move in a long-term game.

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