Arbor Drugs Inc.

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Arbor Drugs Inc.

3331 W. Big Beaver Road
Troy, Michigan 48084
U.S.A.
(810) 643-9420
Fax: (810) 637-1634

Public Company
Incorporated: 1974
Employees: 5,200
Sales: $618.56 million
Stock Exchanges: NASDAQ
SICs: 5912 Drug Stores and Proprietary Stores

With 160 stores across Michigan, Arbor Drugs is the second largest drugstore chain in Michigan and the fifteenth largest in the United States. The company has posted an impressive record of growth since its president, Eugene Applebaum, opened his first drugstore in Detroit in 1963. This performance has garnered the company a place among the Forbes ranking of the 200 Best Small Companies, as well as the Drugstore News award for “Small Chain Drugstore of the Year” in 1993. An emphasis on pharmacy, customer service, and convenience was the formula responsible for Arbor Drugs’s success.

Eugene Applebaum, the founder and president of Arbor Drugs, opened his first drugstore in 1963 shortly after graduating from pharmacy college. Called Civic Drugs, the small store was located in the somewhat rundown east side of Dearborn, Michigan, a suburb of Detroit. “I loved pharmacy and I loved the business side. I also liked fast nickels and dimes,” Applebaum said in a 1993 Forbes interview. By 1974 he had purchased five more stores in the greater Detroit area and decided it was time to incorporate. He named his new corporation “Arbor Drugs” after his Ann Arbor-based store and began to create an image for his new chain of drugstores.

Applebaum made the decision early on in the growth of his chain that Arbor would focus on prescription drugs and personal care products. During the 1970s and early 1980s a number of drugstore chain executives had begun to worry that traditional drugstore items, like cosmetics and personal care products, were increasingly being sold by large discount stores. Since most drugstores could not compete on price with these discounters, chain managers felt that they too must diversify or face obsolescence. Drugstores began to experiment with such diverse goods and services as dry cleaning, electronic equipment, and video rental. Arbor’s main competitor in Michigan, Perry Drugs, even ventured into the auto care business, introducing an extended line of automotive products and services with very limited success.

Instead, Applebaum decided to stick with more traditional drugstore items. In the 1960s, at his original Civic Drugs store, Applebaum had experimented with selling records and learned that such fashion-driven markets could be wildly unpredictable. When a Beatles record would be released, the store would sell out, “But we were always stuck with too many Montavani,” Applebaum joked in a 1993 interview in Drug Topics. “We learned and we never mix mascara with motor oil. Arbor has never strayed from its traditional drugstore format, which emphasizes convenience and health care.”

By early 1981, Arbor had grown to 19 stores, and later that year the company acquired 11 former Cunnigham Drugs locations for a total of 30 Arbor Drug units. Over the course of the next five years the drugstore chain acquired 22 more stores and began its transformation from a small local chain to a major regional presence. In 1986 Applebaum decided that the time was right to take his company public in order to finance further expansion. In preparation for this step Applebaum made one of the few mistakes of his executive career. He opened three stores in the Carolinas in order to impress investors with the geographical diversity of his chain. “Stock analysts asked good questions, like how we’d service the stores, but I didn’t take them as good questions,” Applebaum admitted in Forbes. The analysts were right, and Arbor was quickly forced to retreat from these out-of-state ventures. With good investment from stockholders, Arbor Drugs was able to increase its rate of expansion and add 10 to 15 new Arbor stores a year in Michigan through the 1980s. By 1994, the Arbor chain owned and operated 154 stores.

The 1980s were a period of expansion for drugstore chains in general as many small independents found they simply could not compete with the big chains. Even during recessionary periods during the early 1980s and 1990s, the large drugstore chains continued to grow. Analysts ranked the industry as a whole among the top 10 percent as a good investment risk in the early 1990s. In Michigan, independent drugstores held a larger share of the market through the 1970s and 1980s than in other parts of the country, but during the 1980s both Arbor and its main competitor Perry Drugs continued to buy out the smaller companies at a rapid rate. At the beginning of the decade independents controlled well over half of the market in Michigan, but this share had dropped to only 43 percent by the early 1990s.

Arbor Drugs’s expansion was accomplished through both acquisitions and new store openings. Major acquisitions included the Cunnigham chain in 1981, the Sentry chain in 1986, and the M&R chain in 1994. Toward the end of the 1980s, as Arbor’s profits and assets grew, the company was also able to finance and build an increasing number of freestanding stores. This allowed the chain to expand without relying on retail mall real estate developers or acquisitions. The bulk of Arbor’s acquisitions and new stores were located in southeastern Michigan, particularly in the Detroit area, where rival Perry Drugs had a relatively weak presence. In 1986, Arbor controlled only 13.5 percent of the greater Detroit market, but by 1992 this share had grown to 27.6 percent, surpassing Perry by .1 percentage points. This market share would continue to grow into the mid 1990s.

Part of Arbor’s strength lay in the company’s willingness and ability to expand into neighborhoods that were considered questionable by other large chains. In the early 1990s, for example, Arbor became the first large retailer of any sort in over 20 years to open an outlet in depressed Ecorse, south of Detroit. In 1993 the company opened an outlet in Hamtramck, a largely Polish community in the Detroit area, and promptly hired a Polish-speaking pharmacist to run its pharmacy department.

Large drugstore chains like Arbor Drugs could offer price advantages over their smaller, independent counterparts, not only because of their high volumes but also because of their access to insurance company prescription payment plans, which frequently excluded independent drugstores. Under pharmacist Applebaum, one of Arbor’s main policies was to promote its prescription pharmacy services. As Arbor grew into a large chain in the 1980s, management decided to emphasize pharmacy service by placing the prescription counter in all stores to the center rear at the end of a wide aisle, so that it would be clearly visible from the entrance of the store. The pharmacy enclosure was also open, not glassed in as it was in rival Perry stores, so that the pharmacist would appear more accessible to the public.

Even more significantly, as early as 1979 Arbor was one of the first chains to computerize its pharmacy system so that prescriptions could be filled and refilled more quickly. By 1989, Arbor had extended this service by linking all of its stores in one network, allowing prescriptions to be filled from any store in the chain. Computerization also allowed the chain to keep track of billing for the increasingly large pool of drug insurance plans that were introduced during the 1980s. Beginning in the late 1980s, Arbor undertook a series of major advertising campaigns to promote its pharmacy services. These campaigns were a huge success, and by 1994 an independent polling organization reported that Arbor pharmacies were the preferred prescription centers in southeastern Michigan. The proportion of Arbor’s sales provided by pharmacy jumped from 35 percent in the mid 1980s to almost 50 percent by 1994, at a time when the drugstore industry average was only 33 percent.

Under Applebaum’s leadership Arbor Drugs seemed to lead a charmed existence. Sales grew impressively, but steadily enough not to alarm investors about over-expansion. When the company went public in 1986 it was earning net income of $5.3 million. By 1992 this figure had more than doubled to $15 million. Total sales soared from $150 million to almost $500 million in the same period. Even more significantly, sales at Arbor stores averaged a hefty $471 per square foot, 80 percent above the drugstore industry average. Income from pharmacy also kept growing, vindicating Applebaum’s insistence on promoting this aspect of his business. Arbor made it onto the Forbes list of the 200 Best Small Companies in 1988 and was named Drugstore of the Year by both industry magazines. In 1990 Applebaum was named “Strategic Manager of the Year” by the Planning Forum, and a 1992 poll by Corporate Detroit Magazine found that Applebaum was one of the most admired CEOs in metro Detroit. It began to look like Arbor Drugs could do no wrong.

Arbor Drugs’s corporate honeymoon ended in 1993, however. The year opened with a new Democratic government in Washington promising major health care insurance reforms. Investors reacted by scrambling out of drugstore stocks for fear that government-regulated insurance would pay less for prescription drugs. Between January 4 and February 25, Arbor stock lost 25 percent of its value, which had reached a high of $23.75 in the first quarter of 1993. As it became clear that health care reform, if it ever materialized, would entail a far less dramatic change than investors feared, Arbor stock gradually recovered to about $20 a share.

But then, on July 7, Arbor was forced to disclose that, “after a routine audit,” Blue Cross Blue Shield of Michigan was claiming that Arbor had overcharged the insurance company for prescriptions since 1988. As of July 1993 the total claim amounted to $17 million, which Blue Cross then demanded in payment from the drugstore chain. Wall Street responded quickly, and within one day the price for Arbor stock plummeted by 25 percent to only $15.50. To make matters worse, the U.S. Attorney’s office launched an investigation to determine whether the charges involved criminal misconduct, while the federal government began its own audit to see whether Arbor had overcharged the federal Medicaid program. What had been a sterling rise to the top of the drugstore industry was suddenly marred by a serious blemish.

Arbor Drugs quickly denied any wrongdoing, saying that the dispute with Blue Cross Blue Shield arose from differences of opinion about how the reimbursement formula should be calculated. The main point of contention involved what could be included in the pharmacy’s “cost” for acquiring the medication. Although neither side would release any details about the disagreement, analysts speculated that such gray areas as warehousing, the cost of vials, and the cost of labelling were probably among the disputed items. After months of negotiation the two parties reached a settlement in which Arbor agreed to pay Blue Cross Blue Shield a one-time fee of $15 million and to alter its billing procedures in the future. The following year the company agreed to pay the federal and state governments a total of $7 million in settlement of the Medicaid claims, and all criminal and civil charges against Arbor Drugs were dropped. With the dispute settled, investor confidence in Arbor Drugs was restored, but only at the high cost of $23 million—almost as much as the company’s entire combined net income for the two years prior to the controversy.

Despite the difficult challenges it faced in 1993, Arbor Drugs’s long-term success appeared to be just beginning. Although the company was forced to swallow a bitter pill with the billing dispute of 1993, sales and income exclusive of the settlements continued to rise. By 1994, the 154 Arbor Drugs stores posted sales totalling $618 million, at an average of $4.1 million per store, which was 37 percent above the industry average. As the average age of the American population continued to increase, analysts predicted that pharmaceutical sales would reach record numbers. Arbor Drugs, with its emphasis on prescription drugs, appeared well-positioned to benefit from the graying of America into the twenty-first century.