Morality play

Most CEOs and boards focus on driving growth, raising revenue, pleasing shareholders and positioning the firm for a more profitable tomorrow. Doing the right thing and staying true to one’s values aren’t always at the forefront of board activities or strategic decisions. And then there’s CVS.

In February 2014, pharmacy giant CVS Caremark announced that it would stop selling tobacco products by October 2014. That decision reduces the company’s annual sales by $2 billion – a fraction of CVS’ $126 billion annual revenue in 2013, for sure, but still a noticeable loss. Selling tobacco was no longer consistent with the company’s mission of offering medical and health advice in its 
pharmacies and in-store clinics. How could CVS offer health and medical advice while selling 
products that damage and shorten life?

When CVS announced that its 7,600 stores would jettison tobacco products, it stated: ‘It’s the right thing to do for the good of our customers 
and our company. The sale of tobacco products is inconsistent with our purpose – helping people on their path to better health.’

CVS chief executive Larry Merlo says the timing was appropriate for making this decision. ‘Pharmacies are becoming increasingly involved in chronic disease management to help patients with high blood pressure, high cholesterol and diabetes,’ he explains. ‘All of these conditions are exacerbated by smoking.’ Hence, he says, removing tobacco 
products from the company’s shelves was a health imperative and ‘the right thing to do’.

Merlo acknowledges that he and the board ‘wrestled for years with the inconsistency of selling tobacco in a place where healthcare is delivered – but there was that $2 billion in annual sales to consider.’ Gradually it became clear that selling tobacco was inconsistent with the company’s vision of becoming a major healthcare provider via its clinics. As it saw its revenue rise in its in-house pharmacies, it finally decided to pull the plug on tobacco sales.

Boom time

Another factor contributing to the expected revenue growth at CVS’ pharmacies is the rise in service 
to baby boomers. CVS has more than 26,000 
pharmacists and nurse practitioners, whose role will expand ‘with the aging of the population, prevalence of chronic disease and increasing insurance coverage through the Affordable Care Act,’ Merlo points out. His implication is clear: selling tobacco was sending a mixed message to consumers. CVS couldn’t brand itself as a growing health provider and sell harmful products at the same time.

When Merlo brought the decision to halt tobacco sales to the firm’s board of directors, the board 
operated ‘from a position of strength. Our business outlook is healthy,’ he says. He describes the board’s reaction as ‘100 percent aligned with our decision.’ Moreover, he says, there were no legal impediments to making that decision.

Deciding to relinquish $2 billion in sales was thorny, difficult and complex, Merlo concedes, ‘but more importantly, there was also consideration for what our customers, clients and colleagues, as well as leading health advocacy groups, were saying about tobacco.’ Hence, getting rid of tobacco products was a business decision because it would bring greater revenue in the long run, blended with a moral decision because it would end the selling of 
a product that harmed lives.

The long game

Boards have legal guidelines they must adhere to when making a decision to forego short-term 
revenue, explains Charles Elson, a corporate 
governance expert and professor of finance at the University of Delaware. Directors must ensure the decision is made in the long-term interests of 
shareholders. As long as the board is informed, acts in good faith and is clear that the company will 
benefit in the long run, it is following legal guidelines.

If the CEO brings a proposal such as CVS’ to cut short-term revenue, the board must perform due 
diligence and question how the near-term loss won’t damage the firm in the long term, Elson says. The board has to say to the CEO, ‘You must convince us that this decision may have short-term negative implications but longer-term value.’ If the decision leads to a material change in revenue, the board must then inform shareholders about the alteration and why it has been made.

In other words, the moral dimension of CVS’ decision was moot from a corporate governance 
perspective: getting rid of tobacco was the right thing to do financially.

Rita Gunther McGrath, a Columbia Business School professor and author of The end of competitive advantage: how to keep your strategy moving as fast as your business, endorses CVS’ move as part of 
a strategy to grow, not shrink, revenue. ‘CVS is 
looking to get into more lucrative and fast-growth areas involving health services,’ she explains. ‘The best-case scenario is that, in three to four years, the company will have built robust service businesses with higher profit margins.’

CVS Caremark can now say, ‘We’re all about health, not just about making money’, a strategy that resonates with the 82 percent of the population that doesn’t smoke and is more health-conscious, McGrath says. In terms of revenue, she adds, 
‘cigarettes are a mature and modestly declining business.’ What this means is that CVS is exiting a slow-growth business and focusing on faster-growth markets. That alone strengthens the company’s appeal to investors, McGrath suggests. ‘Shareholders tend to go for companies they think have growth prospects,’ she notes.

Pros and cons

Not everyone is sanguine about CVS’ move, 
however. CNBC’s stock expert Jim Cramer frowned on the decision from a financial viewpoint. He said on CNBC that most investors won’t buy CVS just ‘because it is a good citizen’. He added that ‘the earnings per share for CVS just got worse.’ Nonetheless, CVS’ stock has prospered over the last year. From a low of $55 about a year ago, it spiked 
to $75 in May 2014.

ISI Group analyst Ross Muken downplays the temporary loss of revenue. ‘We believe the move will be viewed as a positive long-term decision by CVS, despite the near-term profit drag, as it paves the way for increased credibility with both healthcare consumers and payers,’ he told investors in a research report. In a follow-up interview, he says CVS’ business ‘is doing phenomenally well. And it is morphing into healthcare services, forming deeper relationships with hospitals, physicians and health plans.’ Abandoning tobacco products was necessary to cement that transition.

Losses were already absorbed into this year’s earnings guidance and carried over into 2014, so shareholders won’t suffer any major declines, Muken adds. ‘Ultimately, [health services] have longer tails and are more aligned with the company’s end-goals,’ he states. Pharmacies at CVS will serve as the 
‘epicenter of community care’ and boost revenue. ‘You can’t be a full-service health provider and also knowingly sell items that harm people,’ he concludes.

How solid does the business case have to be? Robert Ludke, head of the Hill+Knowlton Strategies corporate advisory practice, says his firm’s research finds that 90 percent of Americans believe 
companies need to align their behavior with publicly stated values and 73 percent say they’re more apt 
to do business with firms that specialize in 
‘communicating character’. So CVS has enhanced its reputation, which helps it ‘achieve the company’s business objectives and, if needed, defend itself in a time of crisis.’

Other companies have also taken strong stands to reinforce their values seemingly at the expense of revenue, though these decisions can usually be justified financially. Based on its founders’ religious beliefs, Chick-fil-A closes on Sunday, but former CEO Truett Cathy has said his well-rested staff give better customer service the other six days, and Chick-fil-A can now recruit better talent and hold onto it. In 2011 Marriott began phasing out pornography on its hotel television channels; this was seen by many as a move based on the religious beliefs of the Marriott family, who 
are Mormon, but the company said it was driven 
by economics and technology.

Proof in the aftermath

Since CVS’ announcement, Merlo says, the publicity blitz has reinforced why the decision was made. 
It generated 281 million print and broadcast 
impressions and 200,000 social media impressions.

On the MarketWatch blog, consumer reaction is varied but mostly positive. One consumer calls it a good move ‘because health providers shouldn’t be selling products that do more harm than good’, while another says ‘it will buy CVS more loyal customers’. But another customer suggests that CVS should ‘stop selling alcohol, opiates, psych meds or anything else with damaging results or abused by kids and others.’ And yet another predicts that ‘its sales will go up because the non-smoking consumers (the majority) will react favorably to [this] decision.’

Not only did the board have to sign off on a potentially controversial decision, but now it also has to publicly back up that decision. ‘The board has to signal its support for CVS adopting a new, broader strategy,’ McGrath notes. She says CVS’ board did an effective job of backing the decision ‘by speaking as a unified voice in support, by symbolically embodying the new strategy and by taking it up to the influential people in its network.’ Actions by 
the board and CVS management team show 
that ‘sometimes strategic boldness can be highly 
differentiating,’ she concludes.

Greg Bustin, author of Accountability: the key to driving a high-performance culture, who runs his own eponymous marketing firm in Dallas, says CVS has done a commendable job of communicating with shareholders – in letters, 
web-based communiqués, on 
the CVS website, even in video messages from senior management. But it’s also gained considerable leverage via public relations 
and endorsements outside of shareholders. Organizations such as the American Medical Association, American Cancer Society and American Pharmacy Association have endorsed CVS’ decision. ‘It 
puts the company in a leadership position and 
automatically makes everyone else a follower,’ Bustin says. ‘It’s a win/win. It makes the other guys in CVS’ space play follow the leader.’

No doubt the ‘other guys’ are watching keenly. With Walgreens sidetracked by two big acquisitions in recent years (it acquired Kerr Drugs in fall 2013 and Duane Reade in 2010), CVS has put a key adversary on the defensive. ‘In this strategic move, you get the biggest bang for your buck when you take the competition by surprise,’ McGrath says. In fact, 28 state attorneys general in March 2014 urged Walgreens, Walmart and Costco to join the 
bandwagon and stop selling tobacco products. Their directors must face the same decision CVS’ did: can they do good while doing right by shareholders?