Why Might CVS Be Breaking Up?

News reports indicate that CVS Health may be splitting up in the months ahead.   Company leaders apparently are mulling their strategic options while under pressure from Glenview Capital and other investors.  CVS Health has diversified through acquisition over the past two decades.  In 2006, CVS acquired Caremark, a pharmacy benefit manager.  Then in 2017, CVS acquired Aetna, making a major move into the health insurance business.  More recently, they have made other moves to expand in the healthcare delivery space, such as by acquiring Oak Street Health - a primary care provider.   Unfortunately, the company's stock has underperformed the S&P 500 by a wide margin over the past two years, leading to increasing pressure from investors. 

Why might CVS Health be considering a break-up after moving so aggressively to transform themselves from a pharmacy retail chain to an integrated healthcare company?  Several factors may explain the potential strategy reversal.   

1.  Diversification works best when the different business units within a corporation operate by the same "dominant logic."  C.K. Prahalad and Richard Bettis coined this term in a very famous academic paper published in the 1980s.  They defined dominant logic as "the way in which managers conceptualize the business and make critical resource allocation decisions..."   In short, what is the mental model that leaders use to think about the business and make choices?  Do the businesses make money in a similar manner, or are the value propositions and business models fundamentally different?  They argued that strategic variety and complexity means that multiple "logics" exist across the portfolio of businesses, making it very difficult for the top management team to lead them all effectively.  They cannot apply the same criteria, rules, and principles when making decisions across the businesses.   One could easily argue that the dominant logics at CVS vary considerably from pharmacy retail to health insurance to primary care provision.  Can one CEO and her leadership team manage all these businesses effectively?  

2.  Scale and scope do not always yield economies.  We often hear about the benefits of bringing multiple units together.  In short, what are the economies of scale and scope?  I would argue that managers often focus on these potential economies when justifying acquisitions, yet they underestimate the potential diseconomies of scale and scope.  How might the increased complexity of the business make it more difficult to manage effectively?  What conflicts might emerge among business units?  What costs and disruption might occur as a company tries to secure key synergies?  Do the costs outweigh the benefits of collaboration and integration?  CVS Health has become a behemoth, and at some point, that sprawling conglomerate becomes very hard to manage.  

3.  The existence of potential synergies alone does not justify mergers.  One has to ask whether one could achieve some of these benefits through some other sort of organizational arrangement (stretching from contracts and partnerships through strategic alliances and joint ventures).  Firms don't always have to merge to coordinate and collaborate in pursuit of certain economies of scale and scope.  Consider Target's decision about its own pharmacy business.  The company wanted to continue to have pharmacies within each of its stores.  However, it came to the conclusion that it was best not to try to manage and operate these pharmacies themselves. Instead, they sold the business to CVS, letting the pharmacy experts run the "stores within a store" at each Target location.  Target shed a business, but it retained some of the benefits of having a pharmacy within each of its stores (the pharmacies are good traffic drivers and lead to other incremental sales for Target).  

4.  Vertical integration has many potential benefits, but it does not come without substantial risks. One risk is that you find yourself competing with your own customers at times.  That brings challenges for many companies, including in the healthcare space.  CVS Health has embarked on quite a bit of vertical integration over the years, creating these potential conflicts of interest that can be challenging to manage.