The inside story of why Amazon bought PillPack to crack the $500 billion prescription market

Health, Fitness & Food

It was May 2018, and PillPack CEO TJ Parker was in Seattle to meet with a small contingent from Amazon.

Suitors had been swarming around his online pharmacy, which was taking on CVS and Walgreens and growing rapidly in the process. Walmart was deep in talks with the Boston-based start-up, and pharmaceutical maker Novartis was also hovering.

But bankers from Frank Quattrone’s Qatalyst Partners suggested that Parker and co-founder and product chief Elliot Cohen fly across country for a meeting with one particular Amazon executive: Nader Kabbani. A 14-year company veteran and guest concert pianist with the Seattle Symphony who’d recently been named Amazon’s vice president of consumables, Kabbani shared Parker’s concern about the pharmacy industry and the dominant players’ inability or unwillingness to put the consumer first.

Eventually, Parker and Kabbani were the only ones doing the talking, as all the other participants faded into the background. And from there it didn’t take long for Parker to decide that the bidding had ended. He was selling the company to Amazon.

On June 28, Amazon announced that it was buying PillPack for an undisclosed sum (later revealed as $753 million), snapping up a company that delivers most of the medications consumers can get from their local drugstore packaged in convenient white packets so people will remember to take them, along with automatic refills and 24/7 customer support.

Shares of CVS, Walgreens and Rite Aid tumbled on concern that Amazon was further encroaching on their territory after already taking a huge chunk of the market for toiletries and household goods. In the press release, Jeff Wilke, the head of Amazon’s worldwide consumer business, said the companies would work together to help consumers “save time, simplify their lives and feel healthier.”

What Wilke didn’t say was that Parker, the son of a New Hampshire pharmacist, had plans to surpass $1 billion in revenue by 2020, or that PillPack would soon be negotiating with large insurers to get its service into the hands of many more people while aggressively building out its technology to serve them.

Almost 11 months later and about $100 million richer, Parker’s title is still PillPack CEO, and the only noticeable differences to the outside eye are that his website now says “an amazon company” under the logo and Amazon has a new landing page introducing Prime members to the service. Inside the company, Parker, a 33-year-old pharmacist turned internet entrepreneur, is the face of Amazon’s audacious plan to bust into a prescription drug market that to date has represented perhaps the largest and most glaring gap in its retail empire.

CNBC spoke to a dozen people close to the founders, including investors, friends and PillPack employees for this story, most of whom asked not to be named because of confidentiality agreements. PillPack declined to make Parker or Cohen available for an interview, and neither have spoken publicly since the deal was finalized. Amazon declined to comment and Kabbani didn’t respond to a request for comment.

Here’s a glimpse of what Amazon is now attacking:

Spending on U.S. prescription medications is approaching $500 billion a year and growing up to 7% annually, according to IQVIA, a provider of health data. Roughly 60% of American adults have at least one chronic illness, such as heart disease, cancer or diabetes, and 40% have two or more, according to the Centers for Disease Control and Prevention.

The retail drug market for prescriptions has been dominated by large pharmacy chains, including CVS and Walgreens, and independent pharmacies, which all count on a few middlemen known as pharmacy benefit managers (PBMs) to negotiate prices, as well as a handful of large drug distributors.

Other than Wilke’s statement on the day of the deal, Amazon hasn’t uttered a peep about what it plans to do with PillPack.

What we know is that Amazon acquired an 800-plus person workforce and a high-growth, very low-margin business that, like a traditional retailer, uses the majority of its revenue to pay for inventory. We also know that Amazon has not only been continuously adding household products to its marketplace, but has also been establishing its own brands for things like batteries, toilet paper, light bulbs and towels. As delivery times come down to one day for Prime members, what’s the point of ever driving to your neighborhood pharmacy?

PillPack has spent years going through the hard work of getting licenses to ship to every state except Hawaii, and built a system that automatically manages refills and works with insurers on behalf of customers. It sorts pills and provides dispensers to make everything as easy as possible for users.

Fred Destin, an early PillPack investor, describes it as a “complicated and expensive” space with a potentially “big prize.” In other words, it’s the type of business that Amazon CEO Jeff Bezos loves — huge dollars, antiquated technology and so many regulatory barriers that the “smart money” is staying far away. Bezos also knows something about the industry, having taken a board seat at Drugstore.com in the 1990s after Amazon invested in the company. (Walgreens acquired the online drugstore in 2011 for $429 million and shut it down five years later.)

It won’t be an easy market for Amazon to win. PillPack needs relationships with PBMs like Express Scripts and Caremark, which is owned by CVS, to reach the masses of consumers who get their medicines through insurers. Those businesses were worried about Amazon even before it acquired PillPack, because it’s really the only company that could conceivably break up their control if it were to jump into the distribution market and pressure drug manufacturers to lower prices. PillPack also was a concern because it had the potential to take substantial market share from the incumbents.

“Amazon bought the one company in the space that all the PBMs and other pharmacy businesses were threatened by,” said Yumin Choi, a health-tech investor at Bain Capital Ventures. “The challenge is now they put a stake in the ground and the flag has been planted.”

Amazon has to contend with the added problems that come with a disparate ecosystem of physicians, insurance companies and medical records providers, all with their own silos and disconnected systems. Amazon and PillPack may be able to create a better experience for consumers when it comes to delivering medicines, but playing a role in fixing the other inefficiencies may be out of their purview.

“There’s a lot that’s not under their control,” said Eric Percher, an equity analyst covering the pharmacy supply chain at Nephron Research. It’s not clear if Amazon can change the way “that the patient interacts with the pharmacy supply chain and the payor,” he said.

Parker, who has sandy blonde hair, an unkempt beard and thick-rimmed glasses, doesn’t come across as a hard-charging executive scheming to take down the industry superpowers. Zen Chu, a PillPack investor and adviser who teaches health-care innovation at the Massachusetts Institute of Technology, joked that he looks more like a member of a Grateful Dead cover band, but with “exceptional clarity of vision.”

The pharmacy business is in Parker’s blood. Growing up, his dad owned a pharmacy in Concord, New Hampshire, where the younger Parker personally checked labels on pill bottles and delivered medicines to nursing homes and assisted living facilities.

He went to pharmacy school at the Massachusetts College of Pharmacy and Health Sciences in Boston and, while there, would periodically go to events at nearby MIT to look for students exploring innovative work in health technology. That’s where he met Cohen, who was attending business school after studying computer science at the University of California at Berkeley. At MIT, Cohen co-founded a program called Hacking Medicine for students interested in medical entrepreneurship.

Cohen wasn’t sold on the idea behind PillPack until he went home and saw his dad, who had undergone quadruple bypass heart surgery while in high school, struggling to manage multiple medications. He texted Parker to say he was in, and the pair spent a weekend putting together a prototype, which won the 2012 Hacking Medicine hackathon and landed them checks from MIT’s Chu and his wife and fellow investor Katie Rae.

In 2014, the year PillPack started serving customers, Parker’s dad joined as one of the company’s first pharmacists in the office in Manchester, New Hampshire, located 20 minutes from Concord. The founders would drive to the local IKEA to get furniture for the pharmacy.

At internal meetings, Parker talked about the opportunities to modernize the pharmacy experience and to develop an aspirational brand, like what Warby Parker created in the stodgy eyeglasses market, rather than constantly reminding people that they’re sick.

“TJ used to talk at all-hands about the local CVS, where you’d see aisles stacked with three-liter bottles of Coke with fluorescent lights and grey carpeting,” said AJ Resnick, a director of analytics at Pillpack from 2015 to 2016. In his mind, that “wasn’t the experience that people deserve.”

Growth was slow for the first couple years because PillPack had to file for licenses in every state and needed to open physical retail stores in certain states to stay in-network with the PBMs. It also had an advertising problem, because ad teams at Google and Facebook mistakenly labeled PillPack as a drug manufacturer, which required it to include all sorts of safety issues that weren’t relevant.

Fortunately for Parker, he’d taken a small check from Kevin Colleran of Slow Ventures, an early member of Facebook’s ad sales team. Colleran connected Parker to the right people at Facebook to clear up the matter and get PillPack off what the investor called “the naughty list.”

“Once they got on Facebook, it helped escalate their growth more than other platforms,” said Colleran, who also became close friends with Parker.

Then consumers caught on. By the time of last year’s acquisition, the business was on track to generate $299 million in annual revenue, with plans to more than double in 2019 to $635 million before reaching $1.2 billion in 2020, according to a pitch deck viewed by CNBC. Those are big numbers for a company founded just five years earlier, and proved there was plenty of demand for what PillPack was offering.

But PillPack was burning through $6 million a month at its peak because of the low profit margins and escalating costs of expansion. Some of the high expenses were tied to the development of a back-end software system called PharmacyOS, which the company was designing to automate the process of prescription renewals, billing insurance, getting authorizations from providers and sending out notifications. David Frankel, an early PillPack backer, calls it the “spaghetti connectivity” of the pharmacy world.

Parker knew in 2016 that Amazon was interested in the space through conversations with executives at the company, according to people with knowledge of the talks. Amazon was also dabbling around the edges of the market and would soon start hiring business leaders focused on pharmacy and selling things like at-home DNA tests and over-the-counter medicines.

Having already raised $115 million, including a $60 million round in mid-2016, PillPack needed more capital to keep the business afloat. Parker was gearing up to raise more cash had the deal with Amazon or another bidder not materialized.

By early 2018, it was becoming clear that Amazon could be an ally or a competitor. Parker chose the former option.

For Amazon, which recorded over $230 billion in sales last year, PillPack doesn’t move the needle at its current size. The value for Amazon is in the promise of plugging the delivery network into the giant e-commerce machine, especially when considering that the average PillPack user in 2018 was worth $5,000 in revenue, through insurance payments and patient co-pays, according to the slide presentation.

That’s far more than the average Prime member, who spends about $1,300 a year on Amazon after the $119 annual subscription, according to a 2017 study. Also, most of PillPack’s users are in their 50s and 60s and they’re loyal customers, giving Amazon an older demographic to target with other product promotions. You could imagine signing in to order your blood-thinning medication and seeing a recommendation for shaving cream, toilet paper or nail polish, all things you’d been buying at the store.

Amazon is already using that tactic in reverse, promoting the PillPack service to a targeted group of Prime subscribers. But Amazon can provide a whole lot more to PillPack than access to 100 million-plus Prime users.

One effort underway involves large insurers, who could offer the mail-order service as a perk to their members, and in return provide the company with potentially millions of new customers.

According to a confidential document viewed by CNBC, Blue Cross Blue Shield, a federation of 36 health insurance plans that cover more than 100 million Americans, has reached out to PillPack about providing the service to members. While no deal has materialized, the document says Blue Cross would provide home delivery and other benefits as well as discounts on over-the-counter drugs and possibly a branded medication dispenser.

A Blue Cross spokesperson declined to comment.

Amazon can also add the muscle PillPack needs to stand up to the PBMs, which effectively determine whether a pharmacy is able to get customers. Large employers, insurers and Medicare and Medicaid rely on PBMs to administer prescription coverage, and PBMs have not looked kindly on start-ups delivering medications to the home because many offer their own lucrative mail-order services.

In 2016, Express Scripts, the largest PBM, threatened to remove PillPack from its network, claiming the company was misrepresenting itself as a retail pharmacy instead of a mail-delivery pharmacy. The move would have cut PillPack off from about a third of its customers virtually overnight.

“There were many, many attempts to crush this company,” said Jim Messina, a former White House deputy chief of staff under Barack Obama who was hired by PillPack to navigate the challenges presented by PBMs.

Messina, who joined PillPack’s board in November 2017 along with former Treasury Secretary Larry Summers, laid out an aggressive campaign that involved setting up the website fixpharmacy.com to rally support from existing customers in an effort to reach key policymakers in Washington. Parker set up a war room at the office, where top staffers put in 16-hour days on the #fixpharmacy crusade. In just over a week, the marketing team, led by former IDEO executive Colin Raney, published multiple videos featuring customers talking about their dependence on the service.

TJ will “go to war and fight for his company and try to do things differently,” Messina said.

However, Express Scripts did have a case. The company had given PillPack a contract to sell as a retail pharmacy, and not by mail. PillPack had some physical locations but it was shipping medications to patients from those pharmacies. Express Scripts eventually agreed to give a mail-order contract to PillPack (which is still in effect), but not before Parker fessed up to an “administrative error” that resulted in the company briefly shipping to states where it wasn’t properly licensed.

Brian Henry, a spokesman for Express Scripts, told Forbes at the time that, “there are standards and regulations and industry practices you have to follow.” He declined to provide further comment to CNBC.

Parker’s history with Express Scripts and unwillingness to back down from a fight was one of the qualities that most attracted Amazon to PillPack, according to people familiar with the matter.

“He thought that the only way to make a change is to shine a light on the dark spots, and he had the information on where those dark spots were,” said Zachariah Reitano, CEO of men’s health start-up Roman, which counts Parker as an investor. “He did it in a way where it benefited the patient, and not just for the benefit of his company.”

PillPack is just a piece of Amazon’s expansive plan to uproot the $3 trillion U.S. health-care industry. The company is also working with J.P. Morgan Chase and Berkshire Hathaway on a joint venture called Haven aiming to improve care and bring down the costs. It has plans to open its own health clinics for employees, and there’s a secretive group called Grand Challenge working on telemedicine and applying machine learning to cancer research, among other futuristic projects. Then there’s Amazon Web Services and the Alexa voice division, which have various efforts underway to pull together medical records and mine data.

But for all the indigestion Amazon has created in the pharmaceutical and health-care industries, the company doesn’t appear to have any grand plan yet to take on the market. Cohen spoke at a recent investment bank event and told those in the crowd that there’s no single person in Seattle who owns the health efforts, according to a person who was in attendance.

The immediate objective for PillPack is to keep growing and hiring. The company didn’t insist on retaining its brand permanently as part of the acquisition, according to a person familiar with the transaction, so it could eventually be renamed to something like Amazon Pharmacy.

Amazon is staffing up the business to serve tens of thousands more customers and adding the necessary pharmacists and pharmacy technicians. Amazon has about 50 PillPack job openings listed on its careers site, primarily in Boston and Somerville. Some of the most recent listings are for a packing and shipping specialist and visual designer, and more than half the positions are in software development, including for a “team lead,” tasked with “establishing mechanisms and best practices for a growing team.”

PillPack has bolstered ad spending on TV stations (including CNBC and MSNBC) that reach an older audience, as well as across digital networks like Facebook.

It’s also forging ahead with plans already in place in Phoenix to build out a 175,000-square-foot pharmacy operation, which is about the size of a Walmart Supercenter, to serve as a retail pharmacy and distribution center. The facility has been adding state licenses that will allow PillPack to better serve customers in the western U.S.

When the acquisition was disclosed in June, some analysts speculated that Amazon wanted PillPack because it had pharmacy licenses in almost every state. The consulting firm Kantar said PillPack’s 49 licenses make it “incredibly asset-rich.”

In Arizona, PillPack has been lobbying local officials to allow pharmacy technicians, the people who assist pharmacists, to transfer medications from other pharmacies into PillPack. A handful of employees and a PillPack lawyer showed up at an Arizona State Board of Pharmacy meeting in December to request an exemption from a law that requires pharmacists to handle transfers that come in by phone. PillPack’s representatives said the company already uses technicians for those tasks in New Hampshire (one of the 13 states that allow it) and has a rigorous training program and oversight in place to ensure patient safety.

The PillPack crew didn’t talk about cost savings or the need to rapidly scale, but you could hear the Amazon influence in their argument. For PillPack to function like an Amazon business, it has to get the most of both technology and lower-cost employees. The company was granted a six-month exemption, after which it has to produce a report on findings and error rates.

Since the acquisition last June, Parker has relocated to Park City, Utah, near the company’s sales and business development office. On most Tuesdays, he flies to Seattle, where he recently bought a house, and stays until Thursday.

He continues to work closely with Kabbani, who has facilitated introductions between PillPack’s team and top Amazon executives in areas like AWS and Haven, people familiar with the matter said.

Though Parker and Cohen report to Kabbani, the founders are very much the ones leading the charge. Kabbani is a respected manager who has risen through the ranks at Amazon, helping build the Kindle self-publishing platform and then leading a variety of last-mile delivery projects, including Flex, the on-demand delivery hiring service. But he doesn’t have much experience in health care or drug supply chain, a fact he made clear to the PillPack team during the acquisition talks, according to people familiar with the discussions.

Kabbani’s logistics expertise is likely to play into PillPack’s effort to expand its on-the-ground presence. The company has physical pharmacies in five states — New Hampshire, New York, Texas, Florida and Arizona — which it needs to legally ship to all the various states and so it can deliver quickly, without having to send packages across the country.

Cohen’s focus has largely been on PharmacyOS, which PillPack launched in 2017 as a “brand new operating system that we built from the ground up,” replacing lots of old, off-the-shelf technology.

According to an internal presentation PillPack executives created before the Amazon deal, the company was pitching PharmacyOS as its next big growth driver, and two people familiar with the matter said it was one of the main pieces that interested Amazon. PillPack has been trying to get the technology in the hands of pharmaceutical makers, doctors and insurance companies to automate and streamline their processes as well, so it’s not just used internally.

“Such a move would mean they’re expanding far beyond their core solution to the tens of millions of people who take generic medicines,” said Stephen Buck, a former vice president at drug distributor McKesson, after CNBC described the document. Buck, who’s now CEO of health-tech start-up Courage Health, said it suggests that “PillPack is going to be a much bigger player in pharmacy.”

Just after the deal came together and before taking up his new post in Seattle, Parker wanted to celebrate. He invited some friends and their family members to his home in the Boston suburb of Somerville, a short walk from PillPack’s headquarters, to enjoy a summer barbecue.

Parker and Cohen cooked steaks and veggies on the grill in the garden. Meanwhile, Kabbani took a seat at the piano in the living room and entertained the kids in attendance with classical music. Destin, the early investor, was there with his 12-year-old son, who showed off some of his card tricks. The boy was such a hit with Kabbani that the Amazon executive jokingly offered him a job.

“It didn’t feel like a commercial transaction,” said Destin, the founder of venture firm Stride.VC. “It felt like a family barbecue and that touched me. It reminded me that it’s about people having faith in other people and taking risks on their behalf.”

WATCH: PillPack’s CEO spoke with CNBC two years before the Amazon deal

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