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Amazon.com Takes Aim at Drug Prices

Goliath Internet retailer Amazon.com (NASDAQ: AMZN) may have taken another step toward disrupting the pharmacy market. According to reports, Amazon has obtained pharmacy wholesale licenses in multiple states. The news shook pharmacy retailers such as CVS Health (NYSE: CVS), and drug distributors like McKesson Corp. (NYSE: MCK). Will we all be getting our next prescriptions filled by Amazon.com?

Plans in the works

Amazon has been flirting with pharmacy retail for a long time. Founder Jeff Bezos was a former board member of the now-defunct online pharmacy retailer Drugs.com, and Amazon itself was once a 40% owner of Drugstore.com. Ultimately, Drugstore.com was a failed attempt at shaking up pharmacy distribution, but lessons learned could be shaping the second attempt.

IMAGE SOURCE: GETTY IMAGES.

Earlier this year, Amazon was reportedly investigating how to create an internal pharmacy benefit manager. PBMs act as middlemen between healthcare payers, such as insurers, and drugmakers; they combine the buying power of multiple payers to negotiate lower prices, and take a small cut for their efforts. PBMs also work closely with patients to lower costs, by converting them to generic alternatives when possible and making sure they stick to treatment regimens so that they avoid hospitalization.

Amazon's efforts to build a PBM may currently be limited to internal use, but once it's built, there could be significant benefits to scaling it up by providing services to other big corporations. Amazon also appears to be toying with business models that allow it to take orders for prescription drugs and then coordinate with local pharmacies to fulfill them. This approach was reportedly being tested in Japan earlier this year.

A lot of money up for grabs

Spending on prescription medicines exceeds $300 billion in the U.S. alone, and carving away even a small slice of that huge number could provide enough incentive to convince Amazon to enter the market.

CVS Health and Walgreen Boots Alliance (NASDAQ: WBA) are the big kahunas in retail pharmacy, but they're far from the only companies that profit from drug distribution. Drug distributors that buy drugs at wholesale prices to resell them to PBMs and others generate billions of dollars in combined profits every year. The three biggest of these companies are McKesson, Cardinal Health (NYSE: CAH), and AmerisourceBergen (NYSE: ABC), and according to Drug Channels Institute, they account for 85% to 90% of the market. Over the past 12 months, these three companies produced a combined $6.95 billion in net income.

McKesson, Cardinal Health, and Amerisource Bergen net income (trailing 12-month). Data by YCharts.

The next step

Amazon.com is keeping its plans for reshaping the drug market close to the vest, so only time will tell how big of a splash it decides to make in the industry.

In preparation for potential competition from Amazon, don't be surprised if major companies look to band together to eliminate costs and insulate their market positions. Rumors are already swirling that CVS Health may be targeting an acquisition of Aetna (NYSE: AET) to solidify its standing. There's no guarantee such a deal would win the favor of regulators, but it certainly hints at what could be coming down the pike in terms of mergers and acquisitions.

Regardless of how Amazon's plans shake out, patients will be watching closely in hopes that even the threat of a new low-cost competitor can provide some relief to sky-high drug prices.

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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. The Motley Fool recommends CVS Health and McKesson. The Motley Fool has a disclosure policy.