CVS Jettisons a Cash Cow

The pharmacy chain isn't the first retailer to stop selling tobacco products, nor the first company to forgo a chunk of revenue.
Marielle SegarraFebruary 7, 2014

On Wednesday, CVS Caremark announced that it would stop selling cigarettes and tobacco products, a segment worth $2 billion in annual sales. Much has been written about the decision, which CVS says will erase 17 cents in from its earnings per share annually.

CVS/pharmacy on Garrett Road in Durha...

CVS Pharmacy in North Carolina. Photo credit: Wikipedia

Why would it make this kind of move? Partly to bolster its reputation. CVS will forever be known as the first big drugstore to drop cigarettes, in a country where anti-smoking public-service announcements are ubiquitous and smoking ban legislation is introduced every week.

Indeed, CVS got an immediate pat on the back from President Barack Obama, who thanked the CEO and board of directors at CVS for making “a choice that will have a profoundly positive impact on the health of our country.” The American Heart Association and American Lung Association also lauded the drugstore chain for its decision. In its earnings call, CVS said it would make up the loss in other areas of the business, including smoking cessation programs.

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“I think it’s one of the most brilliant moves from a reputation standpoint that I’ve seen in the last ten years,” says Paul Argenti, professor of corporate communications at the Tuck School of Business at Dartmouth College. “There are other organizations that are doing things more quietly, but to have the courage to forgo $2 billion in sales to enhance your reputation and do the right thing — that’s gutsy.”

Gutsy, sure. Will it pay off financially? Not right away. But Argenti thinks it’s all part of a long-term strategy. “By doing what they did, they aligned themselves more clearly with their strategy as a health company,” he says. “They [got] a bunch of [non-governmental organizations] off their back now and forever. They got first-mover advantage in terms of what they’re trying to do with health care. And they made their employees feel good about the organization.”

Indeed, companies often cast aside or unload businesses that don’t line up with their strategy, he says. General Electric, for instance, sold its plastics division in 2007. “They got rid of tons of profits in plastics, which is one of the most important sectors on the planet, because it didn’t fit in with their strategy,” Argenti says. “[Selling cigarettes] doesn’t fit in with CVS’s strategy and [stopping] enhances the company’s reputation.”

What’s more, there have been other companies that have purged their shelves of tobacco. “Target stopped selling tobacco in 1996, and they didn’t go away,” says  Scott Rostan, CEO and founder of Training the Street. Supermarket chain Wegmans did the same in 2008.

The part of the business that will really benefit from this shift is CVS’s prescription benefits management (PBM) business, Caremark, says Rostan. “Many doctors are saying, ‘We can’t partner with you for patient health initiatives if you’re selling tobacco products in the same store,’” Rostan says. “So Caremark is going to pick up the gains as it transforms itself into a health and wellness company.” But “it’s going to be very hard to quantify that new revenue stream to shareholders,” he says.

At the same time, CVS has the resources to take this gamble. Smaller competitors may not, Rostan says. “That $2 billion in lost cigarette revenue translates to less than three percent of CVS’s retail sales, and less than two percent of its overall sales.” A firm like CVS can afford to take that kind of hit. “But for a smaller store, like a Rite Aid, this is a bigger decision,” Rostan says.

While CVS’s finance department may be hoping to measure any short-term gains from the decision, Argenti says businesses “should stop thinking about the ability to quantify intangible assets in the short term. And in the longer term, finance people need to spend more time trying to figure out how to measure reputation and reputational risk in the same way that they measure operational and financial risk. They just don’t do it.”

“How do you quantify the President of the United States and the First Lady coming out and supporting your business on a random day?” Argenti asks. “How do you quantify every newspaper in the country talking about it? What about the customers who will now go there because they’ve done the right thing?”