It’s not easy to walk away from billions of dollars in revenue a year. But Target is getting good at it.
On Monday, Target (TGT) announced it would sell its money-losing pharmacy business to CVS Health (CVS) for $1.9 billion. The deal will add CVS/pharmacy stores within nearly 1,700 Target locations, vaulting the retailer beyond rival Walgreens (WBA) to become the largest drugstore chain in the U.S.
Five months ago to the day Target announced it would close down its Canadian division and take a $5 billion write-down. That move eliminated almost $2 billion in annual revenue and was hailed by many analysts as a masterstroke by Target CEO Brian Cornell, who told Fortune in a profile this winter that every part of the discount retailer’s business would have to justify its existence in a comprehensive corporate review.
Selling off the pharmacy business will jettison $4 billion in revenue, or about 5% of annual sales. That might make it seem like riskier move. But just as visits to empty stores in Montreal at Christmas made it clear to Cornell that Target’s Canadian misadventure that was siphoning treasure and human capital away from its main U.S. business, the CEO decided that Target just wasn’t good enough in the increasingly complex healthcare business for it to be worthwhile to continue running drugstores. So best to cut your losses.
“This transaction will free up our resources we can deploy in support of our key growth priorities including on-demand shopping, category roles, localization and personalization and the development of new urban format,” Cornell told analysts on a conference call to explain the merits of the deal, even as he noted that Target was not well “positioned” in the pharmacy industry.
At least for now, investors seem to agree, sending Target’s shares up more than 1% on the news.
Here is a closer look at some the enormous benefits Target should reap from the CVS Health deal.
1) Traffic, traffic, traffic
One of the biggest challenges retailers face right now is declining traffic trends. At Target, the number of shoppers visiting its stores has been on the upswing again of late. But the retailer could be doing better especially since Target’s drug business has fallen short on that front.
This is where the tie-up with CVS can help. CVS also owns Caremark, a major pharmacy benefits manager with 70 million members. What Cornell is betting on is that many of these people will come into a Target to get a prescription filled and shop for other items. What’s more, CVS has pledged to make its low-price generic drugs available to any Target customers, something that will attract shoppers.
2) Target wasn’t very good at the pharmacy business
Target’s pharmacy business only generated $4 billion in revenue a year. (At CVS, that is in the tens of millions of dollars.) And only 5% to 7% of Target customers use the store’s pharmacy services.
A lot of that had to do with being what Cornell called “a subscale player.” In contrast, CVS has enormous clout with drug makers, allowing it to get better prices. That’s all the more important given that drugstores in general have also been grappling with lower reimbursement rates from the federal government for the Medicare and Medicaid programs, and from insurance companies, something even more painful for a company like Target and its relatively small drug business.
“They bring scale, they bring cost efficiency, they bring expertise that we just could not,” said Cornell.
3) Target can speed up its rollout of small format stores
Last year, Target opened its first TargetExpress store in Minneapolis, with a view to reach urban dwellers and other customers loath to drive all the way to large suburban stores if they only need a few items. It has since opened a couple more, with more are on the way. But the CVS deal allows Target to speed that up a bit since their deal calls for them to co-develop 5-10 TargetExpress stores in the next two years, essentially doubling the size of the fledgling fleet.
4) Improves Target’s health and wellness offering
One of the centerpieces of Cornell’s plan is to improve the healthfulness of Target’s assortment, whether it be natural food to more athleisure wear and fitness gear. So the CVS partnership means it will be freed up to focus on wellness, but also complement CVS’ growing health offerings for an overall more enticing offering. CVS, with its pharmacy advisor service, and Maintenance Choice, offers customers much more service than Target’s pharmacies ever could.
5) Less distraction from what matters: e-commerce, better food and more localization
Just like the Canadian operation was cut because it was a distraction, Target’s pharmacy got the kibosh because the retailer simply had other more pressing priorities. It’s spending $1 billion on e-commerce this year and is in the process of overhauling its food assortment, to focus it more on organic and natural foods, so it’s more clearly differentiated from competitors and frankly, less blah.
“It’s also going to allow us to make sure we’re elevating our focus on reinventing food,” said Cornell. “As a by product of this transaction, we will be able to elevate our focus on signature categories and accelerate the reinvention of our food offering.” Baby and kids items, health and wellness and apparel are those priority categories.