CVS Health Corporation (CVS)

CVS Health operates the largest pharmacy chain in the United States, with roughly 9,700 stores at any given time, and has spent the past decade transforming itself from a simple drugstore company into an integrated healthcare conglomerate. In 2017, CVS acquired Aetna, one of the largest health insurance companies in America, for approximately 69 billion dollars. The combined company now operates as a healthcare intermediary: it owns retail drugstores where customers fill prescriptions, runs a pharmacy benefits management business that determines which drugs insurance companies will cover and at what price, owns an insurance company that pays for healthcare, and provides workplace health benefits to millions of American employees. This vertical integration is intended to be a competitive advantage, but it also creates conflicting incentives and regulatory scrutiny.

The drugstore business: from convenience to healthcare hub

CVS began in 1963 as Consumer Value Stores, a small drugstore chain in the Northeast. Throughout the 1970s and 1980s it expanded steadily, acquiring regional drugstore chains and growing into a national powerhouse. By the 1990s, CVS and Walgreens dominated pharmacy retail in America. The business model was straightforward: rent or own a valuable street location (often in high-traffic shopping centers), staff it with a pharmacist and cashiers, stock it with over-the-counter medicines, toiletries, snacks, and various other convenience goods, and fill prescriptions.

For decades, CVS was essentially two businesses sharing a roof. The pharmacy — the back of the store — was the engine, drawing customers in daily or weekly to fill prescriptions. Because insurance companies reimburse the pharmacy, the business had a steady, predictable revenue stream. The front of the store — the convenience goods, magazines, candy, cosmetics — was the margin business, where CVS could pocket a full retail markup.

But the drugstore business was under structural pressure. Online retailers like Amazon could deliver goods cheaper and faster than a store. Prescription volumes were not growing as fast as healthcare spending overall, because the number of prescriptions per person was relatively stable even as prices rose. The front-of-store merchandise business was being disintermediated. CVS’s response was to add in-store clinics (medical services at the pharmacy counter), to emphasize generic drugs and private-label merchandise, and to try to be more than a drugstore.

The pharmacy benefits management business

The more important move was CVS’s entry into pharmacy benefits management (PBM), a middleman business that sits between drug manufacturers, insurance companies, and patients. A PBM negotiates with pharmaceutical companies to get discounts on drugs, negotiates with insurance companies (including Medicare and Medicaid) to provide their pharmacy benefits, processes claims, and controls which drugs are available to patients.

PBMs are controversial because they extract value by controlling access to drugs and negotiating prices, while the actual work — dispensing the medication — is done by pharmacies (often independent operators) who receive minimal reimbursement. PBMs argue that they negotiate better prices for insurers and employers, saving the healthcare system money. Critics argue that PBMs are unnecessary middlemen who increase costs by taking margins while negotiating with both sides against the middle, and that vertical integration between a PBM and a pharmacy chain creates perverse incentives.

CVS’s PBM business, Caremark, is one of the three largest in the United States (alongside Express Scripts and OptumRx, which is part of UnitedHealth). Caremark negotiates on behalf of insurance companies, large employers, and government programmes (Medicare Part D, Medicaid) for pharmacy benefits covering hundreds of millions of people. The business is high-margin because it involves little direct cost — Caremark does not manufacture drugs, only negotiates their price and processes claims. This generates steady, growing revenue.

The Aetna acquisition and vertical integration

In 2017, CVS announced it would acquire Aetna for approximately 69 billion dollars. At the time, Aetna was the fourth-largest health insurance company in the United States, covering roughly 22 million people. The deal was controversial and faced regulatory scrutiny, but regulators ultimately approved it.

The strategic logic was clear: by owning both an insurance company (Aetna) and a PBM (Caremark) and a pharmacy chain (CVS), the company could theoretically reduce costs and coordinate care. Instead of Caremark negotiating separately with Aetna for pharmacy benefits, the two could be integrated. CVS stores could become centers of preventive care, directing patients to low-cost generic drugs and in-store clinics rather than emergency rooms. The company could capture margin at multiple points — insurance, PBM, and pharmacy — rather than having those profits go to separate companies.

In practice, this vertical integration has proven difficult and created new tensions. Aetna is not a monolithic business — it sells health insurance to individuals, to large employers, to small businesses, and manages government programs. Not all of these customers benefit from integration with CVS and Caremark, and some have complained about higher costs. Some large employers have pushed back against CVS Health, concerned that the company has incentives to steer toward cheaper drugs and in-store care regardless of what is medically best.

Revenue sources and business model

CVS Health generates revenue from three main streams.

Pharmacy Services (roughly 60 percent of revenue) includes the drugstore business — prescription and front-of-store sales — and the Caremark PBM business. The pharmacy retail business has low margins but high volume. The PBM business has higher margins but involves less direct work.

Health Care Benefits (roughly 30 percent of revenue) comes from Aetna’s insurance operations. Health insurers make money by collecting premiums from patients, employers, or government and paying out less in claims than they collect. This is a lower-margin business than retail pharmacy and is subject to regulatory scrutiny and political pressure over pricing and coverage denials.

Corporate (the remainder) includes real estate, other services, and elimination of inter-company transactions.

The combined company is one of the largest employers in the United States and generates hundreds of billions of dollars in annual revenue.

Conflicting incentives and the regulation question

Vertical integration creates conflicts of interest that regulators are watching carefully. The most obvious is the incentive to steer patients toward CVS drugstores and away from competitors. If Aetna’s insurance plan covers a drug at a lower cost if the patient fills it at a CVS store, does that reflect a genuine cost saving, or is it steering for profit? If Caremark (the PBM) negotiates discounts that it shares with CVS drugstores, is that efficient coordination, or is it favoring the parent company’s retail business over independent pharmacies?

Some independent pharmacies have alleged that CVS Health’s PBM division discriminates against them in favor of CVS drugstores, and that this squeezes their margins. State attorneys general have investigated. In 2023, CVS Health agreed to pay 5 billion dollars to settle a federal antitrust investigation into PBM conduct, though the company did not admit wrongdoing.

The broader question is whether vertical integration in healthcare is beneficial or harmful. On one view, it is natural consolidation that allows firms to cut out unnecessary middlemen and coordinate care better. On another view, it is a dangerous concentration of power in a sector where information asymmetries are already severe and where patients have limited ability to shop.

Challenges and competitive pressures

CVS faces competition on multiple fronts. Walgreens remains a major competitor in retail pharmacy. Amazon has begun entering pharmacy and healthcare, and while it is still small, it represents an existential threat because Amazon can leverage its logistics network and customer trust to undercut prices. Walmart operates a large pharmacy business and also has logistics advantages.

In the insurance space, UnitedHealth is larger, and a host of regional and employer-sponsored health plans compete for business. The government regulates health insurance closely, and any significant change in policy around drug pricing, insurance coverage, or the PBM business could reshape the competitive landscape and CVS’s profitability.

The drugstore business itself is declining as prescription volumes flatten and front-of-store merchandise migrates online. CVS is responding by closing underperforming stores (it has shut thousands in recent years) and reimagining stores as healthcare clinics, but there is no certainty this will be profitable at scale.

How to research CVS Health

The company’s annual 10-K filing (SEC CIK 0000064803) breaks down revenue by business segment. Pay close attention to pharmacy services revenue (the core business) and how reimbursement rates are trending — this is a key driver of profitability that is often opaque to investors. Look at the volume and pricing of the PBM business separately from the retail pharmacy business, as they have very different economics.

Read what management says about Aetna integration and whether the insurance business is profitable. Health insurers have volatile earnings because of medical-cost volatility, so look at the trend in medical loss ratio (the percentage of premiums that are paid out in claims) and in net insurance coverage gains or losses.

Track the number of store closures and openings, and pay attention to in-store clinic utilization — this is where CVS is betting the future. Look for commentary on Amazon and other online competitors.

Finally, monitor regulatory risk. Investigations into PBM practices, proposals to regulate drug prices, and antitrust scrutiny are ongoing and could materially affect the company’s profitability and operating model.