subject: DOL Analysis: Walgreen Co [print this page] DOL Analysis: Walgreen Co DOL Analysis: Walgreen Co
Company Background
Walgreens is one of the largest drugstore chains nationwide that has a strong focus in providing wellness services to customers through vaccines, over the counter drugs and prescription drugs. Charles R. Walgreen started Walgreens in 1901 in Chicago, Illinois, as a local convenient corner drugstore. Around the 1920s, Walgreens began serving its customers malted milkshakes, which was a huge success. The demand grew so much that Walgreens started an ice cream manufacturing plant to meet the high demand of customers. Walgreens pioneered the self service style pharmacy in 1922, in addition to being one of the first major drug chains to provide child-resistant prescription drug containers in 1968. Walgreens has succeeded over the years because of continuous innovation to keep ahead of the competitors; currently Walgreens operates over 7,500 retail stores nationwide.
Degree of Operating Leverage
For the discussion of DOL (Degree of Operating Leverage), we picked three years which were year 2006, year 2008, and year 2009. The reason for choosing these three years is that Walgreen's DOLs for those years are the lowest compared to the DOLs for other sixteen years, as shown on the excel spreadsheet. The operating leverage measures how revenue growth translates into growth in operating income ("Operating leverage", n.d). The higher the DOL, the more volatile the company's EBIT will be relative to a given change in sales, other things being equal ("Degree of Operating Leverage DOL", n.d).
DOL for Year 2006
As shown on the excel spreadsheet, Both Walgreen's sales and EBIT in fiscal year 2006 had increased compared to the amount in Year 2005. EBIT went up by 9.36% compared to Year 2005 (EBIT in 2006 = $2,681.9 million); while sales rose by 12.34% (Sales in 2006 = $47,409 million). The growth in EBIT from Year 2005 to Year 2006 was very small compared to other years' growth. The low EBIT growth could indicate that the company incurred too much variable and fixed cost relative to its sales. According to Walgreen's Year 2006 Annual Report, the company's cost of sales for Y2006 was $34,240,400,000; $30,413,800,000 for Y2005; $27,310,400,000 for Y2004. The cost of sales has increased steadily during the three years. The cost of selling, occupancy and administration for year 2006 was $10,467,100,000; it was $9,363,800,000 for year 2005; $8,055,400,000 for year 2004. The second type of cost is typically considered indirect cost. ("2006 Annual Report", 2006).
The Annual Report also said that net advertising expenses, which are included in the cost of selling, occupancy and administration, were $306.9 million in 2006, $260.3 million in 2005 and $230.9 million in 2004. The advertising cost rose about 18% from 2005 to 2006. Walgreen started spending more and more on advertising. There are no other detailed quantitative statements about Selling, Occupancy and Administration costs. However, the allocation of labor, occupancy, and administrative costs could be pretty subjective. As for the occupancy costs, they are the "whole life costs of buildings and their associated land from occupancy until disposal. These costs may be incurred on a regular or irregular basis" ("Occupancy cost", n.d). A retail drug store chain like Walgreen usually incurs a lot of occupancy cost because each store has to pay the store rental fees. ("2006 Annual Report", 2006).
DOL for Year 2008
The DOL for Year 2008 was 0.68, a little bit lower than the DOL in 2006 which was 0.76. The EBIT for Year 2008 was $3,362 million which increased by 6.71% compared to Year 2007; while the Sales for Year 2008 was $59,034 million which rose by 9.81% compared to previous year. According to Walgreen's Y2008 Annual Report, the company's net sales were $59,034 million, $53,762 million, and $47,409 million for year 2008, 2007, and 2006, respectively. Walgreen's costs of sales were $42,391 million, $38,518 million, and $34,240 million for year 2008, 2007, and 2006, respectively. The selling, general and administrative expenses for year 2008, 2007, and 2006 were $13,202 million, $12,093 million, and $10,467 million, respectively. ("2008 Annual Report", 2008).
The selling, general and administrative expenses did not increase a lot during the three year period from 2006 to 2008. However, the cost of sales changed dramatically. The cost of sales in 2008 rose about 10% compared to Year 2007; but it increased almost 24% compared to Year 2006. According to Walgreen's Accounting Policy stated in the Y2008 Annual Report, cost of sales includes production costs, warehousing costs, purchasing costs, freight costs, cash discounts and "vendor allowances that are not included as a reduction of advertising expense". Again, there are no detailed quantitative statements regarding the cost of sales. The low DOL indicates that the EBIT grows slower than the sales. The EBIT slowed down due to the high cost of sales for Year 2008. ("2008 Annual Report", 2008).
DOL for Year 2009
The DOL for Year 2009 was 0.43; this is the lowest DOL among all the nineteen fiscal years. The EBIT in 2009 was $3,467 million which went up by 3.12% compared to Year 2008; while the Sales for Year 2009 was $63,335 million which rose by 7.29% compared to Year 2008. Both Walgreen's growths in EBIT and Sales for year 2009 were the smallest compared to all other years. As stated in Walgreen's Y2009 Annual Report, the costs of sales were $45,722 million, $42,391 million, and $38,518 million for 2009, 2008, and 2007, respectively. Selling, general and administrative expenses were $14,366 million, $13,202 million, and $12,093 million. On October 30, 2008, Walgreen announced a series of strategic programs designed to reduce cost and improve productivity. As of August 31, 2009, the company incurred selling, general and administrative expenses of $5 million related to these programs. The low growth in EBIT was partially due to the large restructuring related costs. ("2009 Annual Report", 2009).
Growth in Sales
Sales Growth for Year 2000
In 2000, Walgreen had an 18.88% growth in sales; this was the highest growth in sales for the company in the last 19 years. Compared to Gross Domestic Product growth of 3.69%, Walgreens was having very successful year ("World Development Indicators" 2010). 2000 marked the peak of heavy investments in expanding stores and acquiring new stores. Walgreen built its market share by opening up 475 stores in 2000. Walgreen's success lies in prescription sales and its merchandise. Walgreen's President, David W. Bernauer, states that because Walgreen sells necessity products such as toothpaste, prescriptions and shampoo, the company is likely to survive economic recessions ("Dow Jones Factiva", 2001). Prescriptions sales were the backbone of Walgreen's successful sales growth for 2000, prescription sales alone rose 11% from the previous year and comprised of 58% of the company's total sales. Aggressive expansion along with strong sales in prescription helped Walgreen have a prosperous year. ("Dow Jones Factiva", 2000)
Sales Growth for Year 2009
In 2009, sales grew 7.29% marking the lowest growth rate for the company in the last 19 years. GDP growth was -2.44%, reflecting the dire economic state the nation was in ("World Development Indicators" 2010). This particularly low sales growth for Walgreen reflects what a lot of comparable companies around the nation are experiencing due to the recession. In Walgreen's 2009 annual report, they reported that the consumer has been drastically affected by the economic climate. Consumers were becoming increasingly conscious about spending, Walgreen's response to this was to drive sales of private brand products and promote sales on essential items, though weekly specials of these products. Walgreen's total sales were comprised of 34.7% front-end sales (household items, convenience foods and personal care products) and 65.3% prescription sales. Front-end sales were able to grow despite economic hardship because of new store openings. 2009 front-end sales growth was still below preceding years as a result of seasonal items and photofinishing; sale of these types of non-essential purchases were reduced due to the economic climate. ("2009 Annual Report", 2009)
Sales Growth for Years 2006-2008
From 2006 through 2008, Walgreen growth in sales was grew from 12.34% to 13.40% and then declined to 9.81%. GDP growth for 2006 was at a mere 2.67% in comparison national GDP Walgreens was resisting the economic recession ("World Development Indicators" 2010). 2006 started off sluggish for Walgreen but began to pick up in the fourth quarter. Sales growth was negatively affected by a mild flu season, which held down prescription sales for the company. The company introduced ink sales in April to let customers, particularly small business owners, take advantage of the convenient locations of Walgreen stores. In 2006, 64.3% of sales comprised of prescription drugs and 35.6% were from front-end sales. ("2006 Annual Report", 2006)
Walgreen's growth in sales was 13.40% compared to GDP growth of 2.14%, it's apparent the national economy was still struggle, yet Walgreens was still able to increase sales ("World Development Indicators" 2010). In 2007, drugstore sales increased as a result of sales gains in existing stores plus added sales from newly opened stores. Sales comprised of 65% prescription sales and 35% front-end sales. Both prescription and front-end sales increased from the previous year by 1.4% and 1.3% respectively. Walgreen's growth is driven by its well-recognized name that drives private brand sales. Government has also played an important role in Walgreen's sales, due to plans like Medicare Part D, which brings more senior citizens to drugstores to maintain health; however, the government is also reducing pharmacy reimbursements, which affect drugstore sales growth. ("2007 Annual Report", 2007)
2008's GDP growth was a measly 0.44%, while Walgreen was able to maintain a sales growth of 9.81% ("World Development Indicators" 2010). In 2008, sales growth dropped down to 9.81%, the major factor in this decrease in sales growth was due to generic prescriptions. CEO, Jeff Rein states that generics will be a major issue in sales growth in the upcoming years. When generics are first introduced, incentives are paid to pharmacies to encourage their sale, however, when more manufacturers begin producing generic prescriptions the cost and reimbursements by third party payers begin shrink. The economy has drastically affected consumers, 22% of individuals are reducing doctor's visits and 11% are reducing medication usage. Sales growth dropped 3.6% from the pervious year, however, comparable stores' sales growth was only 4%, Walgreen is still able to maintain a strong market share and remain competitive in the economic downturn. 2008 also presented another hardship for the company; it marked the retirement of Walgreen's CEO of 26 years, Jeff Rein. Currently Walgreen is searching for a new CEO, while Allen McNally is temporarily assuming his responsibilities. ("2008 Annual Report", 2008)
Conclusion
In conclusion, Walgreen has been successful over the years through aggressive expansion and consistently staying ahead of the industry in sales growth and earnings. Prescription sales for the company continues to comprise over 50% of its sales dollars and front-end sales of necessity products have supplemented sales in years where new medications were not being introduced. However, despite continual growth in sales, Walgreen's DOL in 2009 reached an all time low. The company incurred large restructuring related costs in year 2009. During the three-year period from 2007 to 2009, Walgreen's Degree of Operating Leverage had decreased consistently. The company did not do so well in terms of DOL in the recent years; this was due to the increase in variable and fixed costs.
