After Another Merger Monday In Health Care, CVS Is Still The Company To Watch In 2018

The health care sector rallied yesterday on another “Merger Monday” with the announcement of Sanofi’s (SNY) purchase of Bioverativ (BIVV) for $11.6 billion, and Celgene’s (CELG) $9 billion purchase of 90 percent of Juno Therapeutics (JUNO). But there’s still one transformative merger that will define and reshape the U.S. health care market in 2018: the CVS/AETNA $69 billion deal announced last December.

CVS is best known for its 9,700 retail pharmacies and 1,100 walk-in clinics, but its most significant profit driver is its pharmacy benefits manager (PBM) enterprise—a middleman between pharmaceutical manufacturers and dispensers like drugstores. The company generated $177.5 billion in net revenue in 2016.

With its purchase of Aetna, another bold company and the nation’s third largest health plan, CVS upended uncomfortable business incentives built into its business model. In theory at least, the CVS PBM has new incentive to bring down drug prices and push for the most efficacious—not necessarily the most expensive—treatment choices, to achieve more competitive insurance premiums. They can also favor common sense preventive and primary care through convenience clinics.

This is what makes the CVS/Aetna deal different. It crosses sectors and realigns previously competing business incentives to better target consumer demand. Most of the merger proliferation we have seen over the past few years involves companies in similar categories within the health care industry. Providers merge with other providers, health plans with other health plans, and pharmaceutical companies with others in pharma.

Realigning incentives is the central problem in the health care marketplace, which is built on thorny knots of unintended consequences and senseless rules that resist untangling. The most famous of those knots are fee-for-service payment rules, still largely dominant, whereby payors reimburse for any and all services, regardless of quality. Among its hazards, fee-for-service incentivizes infections because it results in more care and thus pay better. Nobody thinks that is a good idea, but the business model is extremely difficult to unravel. CVS seems up to the challenge.

CVS Chief Executive, Larry J. Merlo, is the man for the job. His signature style is a laser-focus on the company’s core mission of “helping people on their path to better health,” which he is determined to accomplish even when short-term profit incentives nudge in a different direction. That was why Merlo led CVS to discontinue tobacco sales in 2014, and why CVS recently banned digitally altered photos on cosmetic products sold in their stores. Maybe it sounds logical that a health enterprise shouldn’t sell cigarettes or promote eating disorders and depression, but it takes unusual courage to turn away lucrative business.

Many greeted the news of the CVS/Aetna merger as a play to head off new ventures coming from Amazon or other new players. But what makes me optimistic about this particular deal is the new company’s combination of health industry and retail savvy. Many companies have one but not the other. Enterprising outsiders often enter the health care industry with good backing and an idea that would definitely help patients, only to end up six feet under the health care lobbyists, special interests, regulatory twists, and perverse incentives that have dogged the health care system over decades. There are large graveyards full of great companies that naively believed that normal business models work in health care. CVS is not naïve.


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