Cardinal Health Inc Fundamental Analysis

I assigned Cardinal Health a narrow economic moat due to the company’s establishment of switching costs, and entrenched relationships with its customers which inevitably create a high barrier to entry. Supported by the characteristics of the U.S. drug distribution market, Cardinal Health should be able to generate economic profits for a foreseeable future.

The U.S. drug distribution market is dominated by an oligopoly of three big pharmaceutical wholesalers, which include Cardinal Health, AmerisourceBergen, and McKesson, making up over 90% of the market. The dominance of these three players is expected to continue over the next decade with minor changes in market share.

Pharmaceutical wholesalers play a crucial role in the prescription drug supply chain. While distribution is their primary function, wholesalers also have important partnerships with their customers and can negotiate lower prices with manufacturers due to their purchasing power. They contract directly with manufacturers for branded and generic pharmaceuticals, negotiate for lower rates, and stock a vast array of SKUs associated with prescription drugs. This task is less efficiently accomplished by retail pharmacies on their own. Most of the top 15 pharmacies in the US have long-standing partnerships with one or more of the big three wholesalers.

Cardinal Health services around a quarter of the U.S. drug distribution market, with CVS being its largest customer, accounting for 28% of total distribution revenue. Other customers include OptumRx, Kroger, and Vizient. Cardinal Health has extended its pharmaceutical distribution partnership with CVS through June 2027. The partnership is seen to be mutually beneficial and difficult to replicate with a new wholesaler. Coordination and management systems between Cardinal Health and CVS have been developed over more than 20 years and are difficult to replicate, making it unlikely for CVS to get better pricing by switching to a new distributor.

Switching costs does not always refer to money. It can be the time and effort required to switch from one product, service, or supplier to another. It can include the cost of researching new distributors, the expense of implementing new processes, and the potential loss of benefits or services that were provided by the original distributors. The higher the switching cost, the more resistance a company has to switch to a new distributor.

In addition to pharmaceutical distribution, Cardinal Health offers consulting, logistics, data, and analytics services to its customers. Cardinal Health provides such customised services to its big retailer customers to maximise efficiency and effectiveness, making the relationship between the distributor and customers stronger. Switching to a new distributor would result in the loss of operational expertise achieved over the years of working with the original distributor, which is why major retailers have not switched their distributors in the last 10 years, and the trend is expected to continue.

The reasons outlined above, such as the significant switching costs, customised services, and long-standing partnerships, have helped create a high barrier to entry for new competitors trying to enter the pharmaceutical distribution market. Moreover, the market is dominated by the three established distributors. This makes it difficult for new players to break into the market and gain a foothold, as they would need to build the same level of expertise and trust that Cardinal Health and other big distributors have built with their customers over many years.

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