Pill
A sign marks the corporate offices of PillPack in Somerville, Massachusetts, June 28, 2018. REUTERS/Brian Snyde

In a move that allows it to deliver prescriptions to customer homes nationwide, Amazon (NASDAQ:AMZN) is acquiring PillPack for an undisclosed sum that TechCrunch reports approached $1 billion. The acquisition comes years after Amazon sold off its interest in drugstore.com, a now-shuttered online pharmacy that emerged during the dot-com era, and about one year after rumors emerged that it was considering entering the pharmacy marketplace.

This article originally appeared in the Motley Fool.

Pharmacy benefit managers (PBMs), including Express Scripts (NASDAQ:ESRX), and pharmacy retailers, including Walgreens Boots Alliance (NASDAQ:WBA) and CVS Health(NYSE:CVS), sold off sharply on the PillPack acquisition news. But is this deal as bad for these companies as it seems?

Disrupting a massive market

Amazon has already said that it's creating an internal PBM to serve its 128,000 employees. And it announced that it's teaming up with JPMorgan Chase and Warren Buffett's Berkshire Hathaway to form a nonprofit, in hopes of reinventing the broader healthcare system.

Now, the company's taking direct aim at retail and mail-order pharmacies.

Despite its already having tried and failed once before with drugstore.com, it's easy to understand why Amazon's willing to give this another try. In the U.S. in 2017, insurers, government programs, and individuals spent $397 billion on prescription medication at pharmacies, according to the Kaiser Family Foundation.

Almost 50% of that spending is captured by the top three pharmacies: CVS Health, Walgreens, and Express Scripts. The other half is pocketed by big-box stores, grocery stores, independent pharmacies, and mail-order pharmacies contracted by insurers and self-insured employers.

What is PillPack?

PillPack is a private, venture-backed company that specializes in filling prescriptions for patients who take multiple medications daily. The company's founders are TJ Parker, a second-generation pharmacist, and Elliot Cohen, a programmer and co-founder of Hacking Medicine at the Massachusetts Institute of Technology (MIT).

After meeting through Hacking Medicine, the two entrepreneurs created PillPack to make it easier for patients to take their medications as prescribed. In the past, managing five or more prescriptions per day has proven challenging for patients: Prescriptions are filled at different times during the month, and remembering to take medications on schedule can be hard for elderly patients and patients with multiple healthcare problems. Overall, about 40 million Americans take five or more prescription medications per day, and roughly half of patients fail to adhere to their dosing schedule.

To overcome these challenges, PillPack developed automated systems that synchronize prescriptions so that they're all on the same schedule; renew prescriptions ahead of time; bill insurance companies; and communicate with patients, such as via texts when prescriptions ship.

After PillPack has synchronized a customer's prescriptions to a schedule, the multiple medications are sorted into sealed pill packets that are marked with the date and time that patients should be taking them. These daily packets are connected to one another and dispensed like raffle tickets from a small box that can fit on a shelf or counter, and they're shipped to patients monthly.

PillPack doesn't charge patients for shipping and they don't charge for creating the pill packets, either. Instead, patients simply pay the same 30-day co-pay they'd pay anywhere else.

The big threat

Insurers and employers often turn to companies like Express Scripts to manage prescription drug programs. These PBMs pool together their clients' buying power to negotiate lower prices for drugs from manufacturers. They also provide mail-order pharmacy services, and services designed to help make sure patients take their medicine as planned.

Although investors sold off shares in Express Scripts on this news, the impact on them at first is likely to be small. PillPack already has established relationships with the biggest PBMs, including Express Scripts and CVS Health, and it's an in-network pharmacy option for many of the biggest insurance plans. In other words, PillPack still relies on the traditional model for acquiring and filling prescriptions.

Also, because PillPack serves multiple-drug-per-day patients on a 30-day schedule, it isn't likely to challenge PBMs or pharmacies for business from patients who require few prescriptions, or who want the cost savings associated with filling 90-day prescriptions.

Eventually, Amazon could build PillPack's infrastructure to a point where it challenges PBMs more directly, but for now, I think it's a bigger threat to retail pharmacies.

Arguably, nobody's better than Amazon at distribution. And if Amazon ties PillPack to its Prime service and incorporates Whole Foods stores as a delivery point, it could win millions of customers. Amazon's efforts to speed delivery times, including next-day and same-day services in some markets, could make it a very attractive alternative.

How bad is it for pharmacies?

Amazon loves efficient businesses, so it's probably a big fan of the automated prescription solutions already developed by PillPack. Conceivably, leveraging its supply-chain know-how should accelerate PillPack's operating performance. Depending on how actively Amazon markets PillPack on its site or in its Whole Foods stores, I believe PillPack's sales could climb significantly from their $100 million pace in 2017.

Don't expect a price war at pharmacies, though. Because PillPack charges the same co-pay consumers pay anywhere for a 30-day prescription, Amazon's not competing on price (yet). Any savings it achieves by lowering PillPack's shipping costs and other operating costs, or from negotiating more favorable discounts directly, are likely to benefit Amazon's bottom line, not patients' pockets.

A doubling in sales (or more) would barely dent this industry. And top pharmacy chains like CVS Health and Walgreens Boots Alliance have been moving into adjacent markets, to protect their market share from Amazon and others.

For instance, CVS and Walgreens operate clinics within their stores that allow them to immediately fill prescriptions during a patient visit. Also, CVS Health is attempting to merge with Aetna, an insurer; if that deal goes through, you can bet Aetna members will get preferred pricing if they use CVS Health to fill their prescriptions. CVS Health already offers cost savings to members of its SilverScript Medicare Part D plans who use its pharmacies. Furthermore, pharmacies are investigating their own same-day delivery services, which may allow them to fend off some of Amazon's threat.

In short, disrupting the pharmacy market will take some time. The PillPack deal is a win for Amazon investors; I think PillPack can deliver significant sales growth, and Amazon's scale can accelerate its path to profitability. It's a loss for pharmacies over the long term, but given the sheer size of this marketplace and these companies, I don't expect PillPack to dethrone them anytime soon.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Todd Campbell owns shares of Amazon. His clients may have positions in the companies mentioned. The Motley Fool owns shares of and recommends Amazon and Berkshire Hathaway (B shares). The Motley Fool recommends CVS Health. The Motley Fool has a disclosure policy.