Where Rite Aid Went Wrong

Computerized distribution snafus and charges of software-based consumer fraud have contributed to the pharmacy chain's bottom-line ills.

Multimillion-dollar losses, allegations of software-based consumer fraud, computer problems at an advanced distribution center and a new CIO have put the IT group at Rite Aid Corp. through the wringer during the past two years.

Once known as innovative IT practitioners, the 500 members of Rite Aid's IT staff are now more cautious and money-conscious than ever. "They were past leading-edge," says Loren Foster, a project leader and systems engineer at Rite Aid from 1987 to 1996.

'"We loved it. You got to play with all the new toys," says Foster, now an independent contractor. But these days, he says, "they don't have the luxury to experiment."

For example, Camp Hill, Pa.-based Rite Aid in 1994 became one of the first pharmacy chains to use a nationwide satellite network, which allowed its customers to walk into any Rite Aid store in the U.S. and get prescriptions filled or refilled on the spot.

But having lost $1.1 billion in fiscal 2000 and $461.5 million the year before, Rite Aid is no longer a high-tech playground.

Several factors triggered the red ink, including unfavorable real estate deals, overenthusiastic store expansion plans and questionable accounting practices that were investigated by the Securities and Exchange Commission. These problems forced the company to restate its financial results last August for 1998 and 1999.

Then, IT missteps, such as computer problems at an advanced distribution center, made matters worse.

With $14.7 billion in sales for fiscal 2000, Rite Aid is still one of the world's biggest pharmacy chains. But now it's more prudent about its IT spending, says Don Davis, who was named CIO last February as part of an executive shakeup to address Rite Aid's financial troubles.

Previously, Davis was vice president of application delivery at home improvement chain Lowe's Companies Inc. in North Wilkesboro, N.C. Before working at Lowe's, he managed IT outsourcing at Thrifty PayLess Inc., a Wilsonville, Ore.-based pharmacy chain.

Davis says he came to Rite Aid for the personal challenge. "I've done just about everything I can in retail except be involved in a turnaround situation, which is what this is," he says.

"In the past, the company took more liberty [with IT spending]. We're more cautious about that now," Davis says, acknowledging that Rite Aid has seen an undisclosed number of IT people quit as a result.

For example, before Davis took over IT, Rite Aid had staffed up for a major e-commerce drive. It planned to launch an Internet storefront in 1999 to sell and refill prescriptions online. But then the company decided that buying 25% of Drugstore.com Inc. would be less expensive and more lucrative.

After a 10-year, $7.6 million deal with Drugstore.com was announced in June 1999, "the people associated with the old plan were disillusioned," Davis says. (Rite Aid's stake in Drugstore.com was diluted to 15% after the Internet company's initial public offering in July 1999.)

He declines to cite turnover rates in the company's IT department or specify the size of its IT budget.

Several telephone calls to Kent Whiting, former senior vice president of information systems at Rite Aid, went unanswered.

Still, Rite Aid must be careful not to cut IT spending—and experimentation—too deeply, says Paul R. Brown, chairman of the accounting department at New York University's Stern School of Business.

The use of IT in product and inventory management is central to pharmacies, Brown says. "Rite Aid is still struggling and in an industry that's highly, highly competitive," he says. IT strategy "is one of the last areas where I'd be shooting for no room for error."

Righting Wrongs

In response to its huge losses, Rite Aid has said it expects to spend more than $94 million to reassess and restate its financial results for 1998 and 1999. That includes rerunning mainframe-based accounting systems and paying IT people overtime to work with internal and external accountants and auditors during the process.

Still, Rite Aid doesn't plan to replace its combination homegrown/Geac Computer Corp. accounting system, though Davis had expected to do that when he took the job. "The basic capabilities are OK," he says.

Instead, Davis says he plans to build a new decision-support application to refine financial reports that flow through the accounting department. It will be a combination of an as-yet unselected package and internally built software.

One of the risks Rite Aid faces in spending less freely on IT is falling behind key rivals Walgreen Co. and CVS Corp., says Mark Husson, an analyst at Merrill Lynch & Co. in New York.

A shortage of pharmacists in the U.S. has spurred both of those companies to try to automate pharmacy operations as much as possible and to cut the number of hours pharmacists are needed, Husson says.

If Rite Aid can't keep up, "then there is a big cost pressure from the increased need for pharmacists' hours, and a lesser chance of finding pharmacists who want to work there," he says.

In addition, Rite Aid has spent several months fending off a handful of lawsuits accusing the company of tweaking software at its stores to overcharge some customers.

Rite Aid's cash register software was automatically cross-referencing pricing and pharmacy records to add $1 or more to the price of prescriptions for people without health insurance. Insured customers, meanwhile, weren't being charged extra.

Several states investigated the practice, with Florida eventually suing Rite Aid in 1999. That suit was recently dismissed. New York negotiated a deal in which Rite Aid agreed not to charge uninsured people more money. Last August, the company settled a similar suit in Pennsylvania for undisclosed terms.

The company declines to talk about the policy, except to say that it no longer overcharges uninsured customers. IT staffers were dispatched to Rite Aid's 3,800 stores to disable the homegrown point-of-sale code.

Then, in early 1999, Rite Aid suffered unexpected software problems at a new state-of-the-art distribution center in Perryman, Md. Inventory counts were routinely incorrect, and automated warehouse stocking machines misplaced products.

The glitches delayed the opening of the new warehouse while internal IT and logistics people worked on fixes. Meanwhile, an old center in Pennsylvania had to stay open for an extra five months. All of that meant that profit margins on Rite Aid's products shrank—from 26% in fiscal 1998 to 23% in fiscal 2000.

Most Wall Street analysts who follow Rite Aid rate its stock a Hold and say they're cautious about when and if the company will pull itself out of its financial pit.

Meanwhile, Rite Aid's troubles may provide an opening for competing pharmacy chains. "You pay close attention to what's happening to your neighbors and whether you can leapfrog ahead when you know the other guy is tied down at the moment," says the CIO of a competing chain who requested anonymity.

Yet despite the turbulence at Rite Aid, the company will eventually be an IT leader again, predicts Steve Shaha, an analyst at Gartner Group Inc. in Stamford, Conn.

Rite Aid replaced its CEO, chief financial officer, president and other senior executives a year ago, and it's natural for new management to stop or slow down large IT projects while assessing a company's larger needs, Shaha says. "But there are few competitors in retail pharmacy that could be classified as being more progressive and more enlightened in IT," he adds.

Rite Aid Stock Rise and Fall

Rite Aid's stock price rose to nearly $50 per share in late 1998. But the company reported the first in a string of losses in early 1999. At the end of last year, the stock was worth $2.475 per share.

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Copyright © 2001 IDG Communications, Inc.

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