Amazon's Healthcare Ambitions

August 6, 2018

Healthcare spending represents over 20% of the US economy, as measured by Gross Domestic Product (GDP). This ratio is one of the highest in the world, yet US healthcare is perceived to be highly inefficient. Amazon (AMZN) has set its eyes on the industry with the goal to disrupt it. How far did the e-commerce giant get so far?

 

Amazon has been recently circling the healthcare industry for potential areas of growth.  It has formed a new joint venture with JP Morgan (JPM) and Berkshire Hathaway (BRK) in order to transform healthcare for the group’s employees.  The venture will be led by newly minted CEO, Dr. Atul Gawande. He has been a visionary in the medical and sustainable healthcare fields. Together they are envisioning a new era of healthcare, one with simplicity and a streamlined cost structure.  The fears of Amazon disrupting the industry have pushed major pharmaceutical and insurance companies to merge and revise their strategic plans.  In particular, CVS, a national pharmacy chain, is in the process of acquiring Aetna while Cigna, an insurance company, is trying to buy-out Express Scripts, the last large independent standing pharmacy benefits manager (PBM).  But, will Amazon’s entry into the healthcare space be easy?  Can this joint venture be a success run by a part-time CEO with barely any operational experience of running a large scale business?

 

Being a major pharmaceutical distributor or health insurer requires an integrated supply chain and an intricate web of relationships with payers, PBMs, wholesalers, and pharmaceutical companies.  It requires state licenses to operate.  Amazon has recently acquired online pharmacy startup PillPack for ~$1B. Does this mean they are edging their way into the healthcare space successfully?  Our view is that Amazon is still years away from grabbing any significant market share and scale in the healthcare space.  Although Amazon has been successful in disrupting industries, it has not succeeded in all of its endeavors. The major players in the pharmaceutical distribution and healthcare insurance space will still dominate the field.  They have the distribution, relationships, and infrastructure that provide value to millions of patients already in place.  It will take years of hard work from Amazon to achieve the necessary scale. 

 

The Pharmaceutical Supply Chain is Extremely Complicated and Highly Regulated 

 

 

 

As one can see, there are many moving parts to the above dynamic and indeed many areas that are potentially ripe for disruption.  In 2017, there were about 64,000 retail, mail, long-term care, and specialty pharmacies, which dispensed 5.8 billion 30-day equivalent prescriptions and generated prescription revenues of $412.6 billion.  About one-third of those revenues came from specialty medications, and the proportion attributed to specialty medications is projected to grow in the coming years.

 

Now, let’s look at where Amazon can grow with their acquisition.  PillPack is an online non-specialty mail pharmacy business.  They mostly serve patients who have chronic disorders who take multiple medications on a daily basis.  PillPack is licensed in 49 of the 50 US states and only dispense 30 day scripts (not the more common 90 day mail prescriptions).

 

Let’s look at some interesting pie charts (courtesy of Drug Channels):

 

 

 

PillPack’s estimated annual revenues are $100 million.  This means that they capture only 0.07% of the entire mail pharmaceutical market. The larger PBMs are deeply entrenched players in this space, and it will be extremely difficult to grab market share from them.  Amazon may be able to scale up PillPack’s business model, but how much market share can they realistically capture?  

 

Consumers often choose mail pharmacies primarily for insurance-related reasons. Consequently, payers and PBMs are not genuinely motivated to create a favorable consumer experience and most have mediocre customer satisfaction scores.  Maybe Amazon will be able to change the reputation of mail-order pharmacy, but will the revenue coming into Amazon from this venture be worth it (especially if over 90% of prescriptions are filled at retail)?  We believe Amazon’s main intent with the acquisition was to acquire existing licenses and relationships with larger PBM’s.  It may lead to bigger things from Amazon in the pharma space, but we wouldn’t hold our breath in anticipation of a shift in the health care landscape in the short term.

 

In conclusion, Amazon’s efforts with Berkshire Hathaway and JPMorgan are laudable. The new part-time CEO of the joint venture, Dr. Atul Gawande, is very heavy on prestige but light on operational experience. The acquisition of PillPack is largely symbolic and mostly offers Amazon state licenses for pharmaceutical distribution. We believe there is still a long way before Amazon becomes a real player in the field. The most likely path forward for the e-commerce titan is via a major acquisition. This further makes the case for us to stay long some of the best names in healthcare, especially when valuations are attractive.
 

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