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How CVS plans to replace $2 billion in lost tobacco sales

June 22, 2015, 7:53 PM UTC
CVS Caremark Reports Quarterly Profit Increase Of 25 Percent
Photograph by Justin Sullivan—Getty Images

When CVS Health (CVS) announced in February 2014 that it would phase out tobacco products, its executives said selling cigarettes was inconsistent with its ambition of becoming an even bigger player in the healthcare industry.

Indeed, since then, CVS has changed its name from CVS Caremark and last month bought Omnicare for $10.4 billion to get a bigger foothold in senior citizens’ care — just two of many moves to bolster its position as a healthcare provider.

But what hasn’t been clear, until now, was exactly how CVS planned to replace the $2 billion a year in tobacco revenue its drugstores used to reap — or the foot traffic cigarettes once generated at 7,800 CVS stores, fueling sales of other front-of-the-store general merchandise, from toothpaste and diapers to shampoo and soda.

To recoup that, CVS/pharmacy — as the company calls its drugstores — is updating many of its locations to offer a bigger assortment of healthy foods, and it’s positioning them more prominently in the store. It is also upgrading its beauty sections, adding new private brands and beauty advisors at 1,000 stores. The company is also renaming its CVS/pharmacy in-house brand of products ‘CVS Health.’ The company’s retail unit generated revenues of $67.8 billion in 2014.

“The big question was, ‘How does this front-store fit in with this growing healthcare company?'” Helena Foulkes, the president of CVS/pharmacy, told Fortune last week.

There is no doubt CVS Health as a whole has been on a hot streak. Its Caremark pharmacy benefits management business is growing quickly, with 70 million members — feeding CVS/pharmacy stores a steady stream of shoppers. It will soon greatly expand its prescription-filling business, thanks to its recent deal to buy Target’s (TGT) nearly 1,700 pharmacies. And it is opening more of its MinuteClinic walk-in health clinics.

In contrast, its front-of-the-store, or non-prescription, business, has struggled in the post-tobacco era. Sales in stores open a year or more fell 4% last year, while those at Walgreens, now part of Walgreen Boots Alliance (WBA) rose 2%. And in the first fiscal quarter of 2015, the drop at CVS was 6.1%. (CVS was still selling tobacco in early 2014, but was done phasing it out in October, so the relative declines will moderate as the year progresses.)

CVS Health has stiff competition for front-of-the-store sales. Since Walgreens merged with European druggist Alliance Boots last winter, the combined company has had a fuller portfolio of store-brand products under the Boots name. Those products were hits in Europe, and the company has quickly brought them to the United States. Walgreens has so far remodeled 880 of its stores to focus on new health and wellness offerings, including food. Target is planning to expand its still-small TargetExpress store fleet, which will focus on food and beauty, potentially competing with CVS in some key markets.

At the time of tobacco announcement, CVS CEO Larry Merlo was criticized by some, including customers, for continuing to sell food like potato chips and chocolate bars, even as he talked up his company’s health focus. Indeed, Foulkes said she visited a CVS in Long Island, New York, the week the tobacco exit was announced and was told by the store manager that some customers were asking why CVS didn’t sell less junk food, since it was ditching cigarettes.

Healthier food on its own is a $1 billion opportunity, Foulkes told investors a few months ago, making it a key focus of CVS’ retail shift. CVS is upgrading 500 of its highest-volume stores with an improved food section, which will be near the cash registers at the very front of the store, with a display showcasing nutrition bars and other healthier items. The idea is not for CVS to be where a customer goes to fill her pantry, but rather to offer better on-the-go snacks.

“We weren’t making it so easy to find health foods,” Foulkes told Fortune.

Items like Oreos and candy bars won’t disappear — they’ll just have less prime real estate. CVS is there to “nudge, not judge,” Foulkes joked as she gave Fortune a tour of a new-look CVS store in Manhattan’s Chelsea district.

Fresh, Fast Ready to Go Section--Circular Grab and Go Cooler in Foreground

Another big focus in CVS’ retail revamp is beauty, already a $3 billion-a-year business for the company. Foulkes admitted that CVS is playing catch-up to Sephora, which took an ever-greater share of the low-cost but good-quality beauty market. To make some of that up, CVS is elevating the presentation of the category at 2,000 of its stores, giving it up-to-date displays that emphasize brands and are more enticing. In addition to the beauty advisors at 1,000 of those locations, CVS has introduced some new in-house brands, including Make Up Academy cosmetics and the Skin+Pharmacy skincare line.

But there, too, CVS is running into a lot of competition. Walgreens, whose popular Boots beauty products include No. 7, Botanics and Extracts, has long had thousands of beauty advisors across its 8,000 stores. CVS also has to worry about indirect rivals like Target and even department store Kohl’s (KSS), which have in the last year each added beauty consultants to the selling floor at hundreds of stores.

Beauty--Wide Angle Aisle Shot

For a company that generates about $19 billion a year in retail sales (excluding prescriptions) and gets 5 million visitors a day, the overhaul of stores is a risky, but necessary move.

“Walking away from $2 billion is never something easy,” Foulkes said. Replacing that $2 billion might not be so easy, either.