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NYC DRUGSTORES NEVER MORE THAN A FEW STEPS AWAY

BY NANCY COHEN

Photo: Ian Ritter

Now showing all over NYC: Duane Reade.

A new kind of drug war has broken out on New York City’s streets. Over the past five years, the city has become the battleground in a fight over turf among chain drugstores.

Three chains in particular have transformed the streetscape as they jockey for market share, their storefronts situated, in many cases, a mere block or two away from one another. Nearly every American lives within five miles of a drugstore, according to the National Association of Chain Drug Stores — but every New Yorker, it seems, lives within five steps of one.

“The strategy is in-your-face,” said Robin Abrams, executive vice president of Lansco Corp., a New York City commercial real estate brokerage. “You walk out the door, and there’s one; wherever you go, there’s another one.”

Duane Reade, a drug chain born and bred in New York, has aggressively expanded since 1998, when it had 67 stores, into a 239-unit local powerhouse. About 85 percent of its stores are in the city’s five boroughs — Manhattan, the Bronx, Brooklyn, Queens and Staten Island — with the rest operating in nearby suburbs of New York and New Jersey.

By blanketing the city with branches, Duane Reade has maintained its leadership of the nation’s largest drugstore market, where sales jumped 17 percent in 2002 to $8.8 billion. But CVS and Rite Aid, which operate thousands of drugstores across the country, have made some inroads since entering the New York area in 1995, growing to about 100 and 160 units, respectively.

Manhattan’s Upper West Side is probably a typical New York City neighborhood in terms of the ubiquity of its drugstores. Last year The New York Times counted 11 chain drugstores and five independently owned pharmacies on the 30 blocks of Broadway from 76th to 106th streets; additional drugstores line the parallel avenues. Nearby, on Columbus Avenue between 89th and 90th streets, two Duane Reade stores actually face each other across the avenue — apparently assuming that a city of pedestrians won’t cross the street for a tube of toothpaste.

Could the omnipresent drugstore be a stroke of tactical genius? Or is it simply overkill?

According to Anthony J. Cuti, Duane Reade’s chairman, president and CEO, it’s merely a reflection of the unique physical constraints in New York City, where large retail spaces are hard to come by and a successful store is likely to be hemmed in on all sides. Unable to expand a “maxed-out” unit, he told Drug Store News in 1999, “we build another store two blocks away, but we keep the first store open too.” He called the strategy “planned cannibalization.” (Cuti did not respond to requests for an interview with SCT.)

Others, however, view Duane Reade’s proliferation as an audacious defense against the national chains. “They’ll outbid everybody else to protect their turf,” said Faith Hope Consolo, vice chairman of Garrick-Aug Worldwide, a New York City brokerage. “And they take second and third locations within blocks of the first to protect their hold on the neighborhood.”

At certain sites, drugstore competition has driven rents 15 percent to 20 percent beyond their value, says Victor Menkin, president of New York City-based Menkin Realty Services, which specializes in retail brokerage and consulting. “It was more important to brand the location than to make money there. In the process of growing the company, Duane Reade made it prohibitive for the nationals to enter the market. They’ve played their hand pretty well.”

It was only after national chains expressed an interest in the New York market in the mid-1990s that Duane Reade began its dynamic rise. Founded in 1960 on lower Broadway between Duane and Reade streets, the company had grown to 67 stores by 1998, when it went public. Over the four years following, it more than doubled its sales, from $587 million (generated by 128 stores) to $1.27 billion (228 stores) in 2002.

Meanwhile, the national chains — CVS (which operates 4,124 stores in 32 states), Rite Aid (with about 3,400 stores in 28 states) and Eckerd (which has more than 2,700 units in 21 states) — penetrated New York City more slowly than they had anticipated. In 1999 Woonsocket, R.I.-based CVS announced plans to add 200 New York stores to its base of 47 over the next three years. The current store count — about 100, according to media relations director Todd Andrews — doesn’t come close to those projections.

Rite Aid, Harrisburg, Pa., also scaled back its plans. In 1999 the company said it aimed to increase its 147 stores by more than 50 percent within three years. More than four years later, the Yellow Pages lists some 162 stores in the city, a 10 percent increase. (Company officials did not respond to requests for precise information.)

Clearwater, Fla.-based Eckerd attempted to establish a presence in New York City through its 1998 acquisition of the local Genovese chain, then 141 stores strong, now down to 60. According to Drug Store News, Eckerd plans to add 18 stores to the market by the end of next year, but the struggling chain’s future is unclear. J.C. Penney, which acquired Eckerd in 1997, put it on the block in October.

As for Walgreen, the U.S. market leader, it has sketched only modest designs on the city to date. The chain has a couple of dozen stores and plans to open two or three next year.

In an industry overwhelmingly dominated by four companies, it is decidedly unusual for the No. 1 market to be led by a chain unknown beyond that market’s borders. (On a list of the country’s top 100 drugstore markets compiled by MMR, a magazine for mass-market retailers, the only other markets dominated by local chains that lead no other markets on the list are Wilmington/Newark, Del., ranked No. 66; Canton/Massillon, Ohio, at No. 75; and Tulsa, Okla., No. 80.) New York City brokers credit Duane Reade’s nimbleness and local know-how with stemming the national chains’ incursion. That, combined with the city’s unique challenges — including sky-high occupancy costs, a dearth of large, uniform store spaces, and complex distribution and operations logistics — handed Duane Reade a distinct hometown advantage, they say.

‘Too many,’ one local group said, staging a boycott that closed a CVS like this one.

“The nationals have a huge learning curve in any new market, but especially in New York,” said Abrams. “They’re trying to do their typical layouts, which you can’t do here. You won’t get a perfect box or this amount of frontage. Duane Reade is very flexible in their real estate — they’ve even taken old theaters and other multilevel sites the others weren’t comfortable doing.” Although Duane Reade’s stores average 7,000 square feet, they range from 1,600 to 14,500 square feet.

Rents presented another barrier to entry. “You’re talking as high as $200 a [square] foot, and that’s nosebleed territory for a drugstore,” Duane Reade’s Cuti told Drug Store News in 1999.

New York City real estate by no means fits most retail chains’ pro formas, Menkin notes, “but once they saw the volumes Duane Reade was cranking, they couldn’t ignore it anymore.” In the mid-1990s Duane Reade reportedly generated sales per square foot in excess of $1,300 — almost four times the industry average.

Beyond its local expertise, Duane Reade may simply have been in the right place at the right time. It was in a position to expand, following a $120 million IPO, while its competitors were distracted. Although CVS, Rite Aid and Eckerd have now revived their expansion plans, they all contracted in recent years while contending variously with acquisitions, relocations, operations and, in Rite Aid’s case, an accounting scandal that sent former executives to prison for fraud.

During the same period, a window of opportunity presented itself to Duane Reade. “There was all this space — former banks, Gaps, big restaurants, like Harley-Davidson, that failed,” said Consolo. “By virtue of the retail climate, they could cover the streets.”

Drugstore-covered streets are not popular with all New Yorkers, however. In a celebrated case, residents of Manhattan’s Upper West Side protested what they deemed one drugstore too many. Some 4,400 people signed a petition to boycott a CVS that replaced a supermarket on 102nd Street and Broadway and brought to five the number of drugstores within four blocks. The store opened in the summer of 2000 and closed within 18 months.

Despite this rebuff, CVS remains undeterred about the market’s prospects. “There continues to be tremendous room for growth,” said Andrews. “It’s a densely populated and understored city.” CVS plans to add another half dozen units citywide within the year.

Although he wouldn’t project how many drugstores the city could ultimately support, Andrews notes that explosive demand for prescription drugs is driving the segment’s expansion. (U.S. sales of prescription drugs increased 11.3 percent to $183 billion in 2002 and are expected to more than double within 10 years, reaching $446 billion by 2012.)

In fact, New York’s burgeoning drugstore market (see chart) reflects not only surging pharmaceutical sales, but two profound shifts in drug retailing. As has happened across the country, the independent corner pharmacy has given way to the large chain drugstore, which has itself evolved into a kind of convenience store. Sales of basic groceries, cleaning supplies, paper goods and other everyday necessities are boosting the volumes high.

Don’t like what you see? Chances are there’s another drugstore across the road. Rite Aid has about 162 stores in the city and a 21 percent market share.

In a city where supermarkets have declined, chain convenience stores are rare and storage for big shopping trips is limited, the drugstores’ inescapably abundant locations and breadth of merchandise do suit local shopping patterns, says Abrams. “Here it’s about running in as you pass by on your way to the office, getting orange juice or milk on your way home, picking up a few items a few times a week.”

Even so, she said, “we don’t need as many [drugstores] as there are. It’s similar to the coffee bar wars of several years ago — one or two chains will end up dominating, and the others will fail.”

And for all its success maintaining control of the market so far, Duane Reade will have to reckon someday with the high cost of doing so, she says. “They did a lot of deals and paid very aggressive rent. Eventually that should catch up with them, and they will have to close some stores.”

The self-cannibalization has already taken a toll on Duane Reade’s sales per square foot. Although the company still leads the industry by that measure, sales per square foot tumbled from $1,040 in 1998 to $836 in 2002.

Its standing on Wall Street has also taken a hit. In October Merrill Lynch downgraded its investment rating on Duane Reade to “sell” from “neutral” after the chain slashed its quarterly and 2003 profit outlooks, largely blaming a soft economy. Its stock, priced at a 52-week high of $20.45 in October 2002, had dropped to $13.45 a year later.

Its expansion may finally be slowing, too. Duane Reade had announced plans to open as many as 20 stores in 2003, but by the end of October showed a net gain of 11. This slowdown might stem in part from renewed competition for real estate as different kinds of tenants enter the market, perhaps restoring some diversity to the streetscape in the process.

“They’re starting to see resistance,” said Consolo, “because the banks are back — small ones like Wachovia, Independence, Atlantic, that are new to the market, want to position themselves and are paying more rent. And landlords like them because they’re clean, they build great-looking units, they have no glaring signs, no deliveries at midnight. And everyone likes to live above money.”

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