Cost Plus Drugs: Prescription for Success
By: Valerie Phu & Karen Truong
The Ivey Business Review is a student publication conceived, designed and managed by Honors Business Administration students at the Ivey Business School.
Cost Plus: The Golden Cure
Launched in January 2022, Cost Plus Drugs Company (Cost Plus) is a U.S. based online pharmacy established to challenge the epidemic of exorbitantly priced medication. Cost Plus can provide affordable generic drug options by cutting out pharmacy benefit managers (PBM); PBMs typically act as the middleman between insurers, pharmacies, and drug manufacturers to ensure favourable pricing for medications, but as a result, the PBMs often take a large margin in the process. More specifically, the total revenues of the nine largest PBMs equated to almost 45 percent of Americans’ healthcare bills in 2022, up 20 percent from 2013. Cost Plus’ mission strongly resonated with the American population, as the company was able to surpass $25 million in sales and 1 million customers within its first nine months of operations. Cost Plus plans to build an $11 million drug manufacturing plant in Dallas by the end of 2023 to keep up with demand, which will be integral to Cost Plus’ supply chain and their ability to diversify revenue streams – ultimately helping Cost Plus achieve faster and more stable growth.
Pill Playbook: Understanding Pharma’s Game
The U.S. pharmaceutical industry is divided into two segments: branded and generic drugs; with the branded segment making up 84 percent of the market. Branded drugs are defined as those with proprietary patents, which provide the owning company exclusive production and distribution rights. On the other hand, generic drugs are chemically equivalent to their branded counterparts but are produced by non-proprietary manufacturers after the expiration of the patent (typically 20 years). A prime example is Advil and Ibuprofen; both drugs contain the same ingredients, but Ibuprofen is the generic counterpart to the branded Advil.
As a consequence of the highly consolidated nature of the U.S. pharmaceutical industry; the resulting power distribution has enabled leading pharmaceutical companies to dictate steep price levels for branded drugs. Although generic drugs are a common alternative, their development is restricted by the rigorous FDA approval process and the patents held by brand-name drugs. To add, many pharmaceutical companies that own proprietary drugs tend to regularly extend their patent’s lifetime by evergreening– a process where minor product adjustments allow the patent to be renewed. Thus, Cost Plus’ potential in the generics segment is comparably small in the U.S., due to both the smaller segment size of generic drugs and the overwhelming power of pharmaceutical companies to dictate patent outcomes. As such, Cost Plus should consider expanding geographically to broaden its potential consumer base and therefore increase demand for its products.
As a public-benefit corporation, Cost Plus was created to take on the dual mission of improving public health and making a profit. However, relative to established Big Pharma, Cost Plus cannot tackle the root cause of inflated drug prices in the U.S. – which are the regulations and patents surrounding branded drugs. Considering obstacles to achieving both their financial development goals and social mission, Cost Plus should explore international expansion to capture future growth potential and impart positive social change in the area of accessible drugs and healthcare.
The Quest for Quality: India’s Pharma Balancing Act
India's pharmaceutical sector is a global powerhouse, rightfully earning its title as the “Pharmacy of the World”, with projections estimating that the domestic drug market will reach $130 billion by 2030, a CAGR of 6.97 percent. With a strong infrastructure, low production costs, and a large pool of skilled scientists and engineers, India is the largest supplier of generic drugs in the world. Unlike the U.S. pharmaceutical industry, the generics segment dominates 70 to 80 percent of the market.
India’s current population is 1.4 billion and is expected to grow to 1.7 billion by 2050. Despite being the “Pharmacy of the World”, India faces two major challenges: the first being quality assurance, the second being financial barriers to medication. Due to the government’s lax regulatory oversight, the country has been plagued by persistent drug recalls. For example, there are many illegitimate generic drugs due to the lack of quality testing facilities across the country, with only two percent of India’s generic drugs being tested. Furthermore, low-income citizens face high financial barriers to accessing life-saving drugs, with 27% of deaths occurring due to this issue. Essential medicines were also often unavailable for purchase; in bustling districts like Mumbai, almost half of essential medicines were out-of-stock.
Considering Cost Plus’ new manufacturing facility in Dallas, with plans of continued expansion, Cost Plus is well-equipped to fill the supply and quality gap, while also positioning itself to satisfy future demand, while emphasizing its public-benefit brand and social mission.
PharmEasy: The Soar and Subsequent Sores
Launched in 2014, PharmEasy is a leading online pharmacy and medicine delivery platform in India. Similar to Cost Plus, the business idea stemmed from the co-founders’ desire to provide affordable and accessible healthcare. PharmEasy provides a myriad of products and services, including online consultations, diagnostic tests, and medicine delivered to your front door. As of 2023, PharmEasy operates more than 10,000 retail stores in over 700 cities, with a strong commitment to online customer orders and requests.
Since its inception, PharmEasy has raised $1.2 billion in total investments over 16 rounds. With the goal of vertical integration, PharmEasy used the funding to purchase various regional distributors, logistics companies, and supply chain platforms. Consequently, PharmEasy’s net debt increased from $35 million to $293 million within one year, and the company’s net debt-to-equity ratio quadrupled to 0.34. PharmEasy was counting on its upcoming IPO at the end of 2021 to repay its debt obligations; however, at the planned time for its IPO, the markets crashed. Due to poor financial decisions made after the delay of its IPO, PharmEasy’s valuation fell from $5.5 billion in October 2021 to $600 million in June 2023 – a 90 percent markdown.
Cost Plus Calls on PharmEasy
In the event of an expansion into India, Cost Plus’ strengths lie within their production of high-quality drugs, which would greatly aid the business in standing out amongst competitors. Conversely, the greatest areas of weakness would be a lack of domain knowledge and distribution network. As one of the largest online drug platforms in India, PharmEasy possesses the resources to easily fill those gaps. PharmEasy’s current financial challenges present a unique opportunity for Cost Plus to purchase a majority stake in PharmEasy at a steep discount and gain its industry expertise and resources. For PharmEasy, the acquisition will also boost investor confidence, which would aid the company in successfully securing further funding, despite recent failed attempts.
Counting Pills and Profit
Based on PharmEasy’s post-money valuation estimates, Cost Plus should acquire 51 percent of PharmEasy to become a majority shareholder of the business. With a majority acquisition instead of a complete buyout, Cost Plus will have control of PharmEasy, allowing them to dictate the strategic direction and operational policies without needing to fully assume PharmEasy’s debt. This constitutes a purchase price of approximately $306 million. As the controlling entity, Cost Plus will be responsible for the management of PharmEasy, with the post-acquisition opportunity for Cost Plus to restructure or refinance the company’s debt under more favourable terms.
A good measure to assess Cost Plus’ ability to afford the acquisition is its profit from core business operations, specifically medication sales. A strong profit is favoured by lenders, should Cost Plus need to partially finance the acquisition through debt. Cost Plus transparently states that they add a 15 percent profit markup on each order. Of Cost Plus’ 2 million active customer base, 70 percent is assumed to have refill orders with the remainder being one-time purchases. Presuming an average spend of $200 per order, Cost Plus’ profit on medication sales is estimated to be $228 million. Based on this figure, Cost Plus would likely need to secure additional financing for this acquisition. As Cost Plus is still in the growth phase, venture capital is a viable option. This acquisition is feasible given Cost Plus’ projected growth trajectory and the likelihood of securing additional funding; creating a solid foundation for this strategic expansion.
Drug Draft: Choosing Cost Plus' Lineup
To hit the ground running in India, Cost Plus could utilize PharmEasy’s already established distribution network, in conjunction with the 25 million data profiles that PharmEasy has been accumulating from its registered users, to effectively align company operations with customer preferences and buying habits. Using PharmEasy as the foundation for Cost Plus’ initiatives would allow the company to introduce high-quality generics – something that essentially does not exist in India, which would contribute greatly to improving the accessibility to safe and affordable medicines in India while growing Cost Plus’ customer base.
Cost Plus must adopt a strategic approach when entering the Indian pharmaceutical market via PharmEasy’s network. Given the economic landscape, it is not viable to introduce their entire portfolio of generics simultaneously, as Cost Plus would face considerable logistical and financial challenges. A phased approach is recommended, which starts with generics that are highest in demand, according to PharmEasy’s historical sales data. Domestic market analysis indicates that there is a robust demand for generics treating diabetes, cardiac ailments, and gastric issues. Therefore, Cost Plus should prioritize the distribution of these select generics and high-demand products specific to PharmEasy.
Tuning Into PharmEasy’s Channels for Cost Plus' India Entry
As of March 2023, PharmEasy has over 25 million active users, 2.5 million of whom contribute to PharmEasy’s revenue through purchases. Findings have shown that Indian consumers perceive foreign brands to be generally superior and better quality compared to their local counterparts. Moreover, many are not prejudiced against trying a foreign brand should it prove its quality. Assuming that 10 percent of the existing customer base would be willing to try a foreign brand and three percent of that figure purchases Cost Plus’ medications, the company could expect to capture 0.3 percent of PharmEasy’s existing transacting customer base.
Though this is a relatively small figure, with word-of-mouth marketing, which remains the most trusted source for product recommendations in India, Cost Plus could expect to increase its sales year-over-year on the assumption that Indian consumers react positively to its products. With about 10 to 20 percent of Indian consumers making recommendations daily, Cost Plus could expect to increase their capture of PharmEasy’s existing transacting customer base to 1.4 percent, up 79 percent from the first year. While initially acquiring a part of PharmEasy's existing customer base presents its challenges, the upward trend in the Indian market's receptivity to international brands, combined with its commitment to high-quality generics, Cost Plus is well-positioned for significant growth and market penetration in the coming years.
Cost Plus’ Social Dose
Through this partnership, both Cost Plus and PharmEasy would be able to demonstrate a strong commitment to their social mission of eliminating barriers to accessible and affordable medicines. Currently, the total annual household expenditure on medicines in India is $17.3 billion, with generics taking a 75 percent share. Post-acquisition, Cost Plus would be able to provide affordable and high-quality generics in India, which are typically 30-80 percent cheaper than their branded generic counterparts. Assuming an average cost-saving of 55 percent for unbranded generics produced by Cost Plus, and a one percent annual growth for five years, the Indian population would observe $2.5 billion in annual savings, or 15 percent in savings as a percentage of annual expenditure on medicines. On the higher end, assuming a doubling effect in growth every year for five years, $5.3 billion or 31 percent in savings as a percentage of annual expenditure on medicines would come into effect.
PharmEasy and Cost Plus: Merging Remedies for Market Dominance
This acquisition would alleviate PharmEasy’s financial burdens, and bolster its reputation by aligning it with a brand that shares a commitment to delivering quality pharmaceutical solutions. For Cost Plus, acquiring PharmEasy would create a smoother market entry into India which paves the way for Cost Plus’ potential long-term growth beyond the U.S. market. Ultimately, integrating Cost Plus and PharmEasy’s strategies and their shared commitment to providing affordable medication to all is a key approach in redefining both companies’ future trajectories. Striking a balance between financial viability and a deeper societal purpose, the concept of Cost Plus not only ensures economic sustainability within the pharmaceutical industry but also serves as a prescription for driving meaningful social change.
