THE INDUSTRY STANDARD,  September 18, 2000



Can Any Medicine Cure PlanetRx?


By KARL SCHOENBERGER

When William J. Razzouk took on the position of CEO at the upstart Internet pharmacy PlanetRx in the fall of 1998, he had his marching orders from major investors: Turn the company's modest efforts at selling online prescription drugs into a viable business that could compete for dominance on the Internet. And do it quickly.

Razzouk, a veteran logistics expert from FedEx - a company known for planes that fly on time - applied the same kind of discipline to the scrappy band of struggling entrepreneurs. But it soon became painfully clear that Razzouk's tough and regimented style was at odds with the informal culture of this Oakland
, Calif., startup, according to a half-dozen current and former employees and individual investors.

Meanwhile, with Razzouk's executive team hell-bent on rushing to market and building a brand, executives cut costly and questionable deals. But they failed to execute a very important one - an alliance with a brick-and-mortar prescription drug retailer.

Efforts to rescue the company began in April amid the tech-stock crash panic, when it announced a major retrenchment and layoffs of 70 employees. At the end of August the company said it would cut another 50 jobs and relocate its headquarters from South San Francisco, Calif., to its distribution center in Memphis
, Tenn. By then, Razzouk was gone, and CFO Steve Valenzuela had resigned.

Today the company is hanging by a thread, bleeding scarce capital while its Nasdaq stock price has dropped below the dollar level. When the tide turned against business-to-consumer Internet commerce shares, the company was wounded more gravely than its online pharmacy rivals because it lacked an offline drug chain partner. Perhaps most important, it had also failed to negotiate an advantageous deal at the real power core of the sector, the pharmacy benefit-management industry. The benefit managers control medical insurance contracts, thereby dominating the most profitable part of the prescription drug market. Could the troubles at PlanetRx mean that online prescription drugstores simply weren't meant to be?



So it wasn't all Bill Razzouk's fault, but he was replaced in April by Michael Beindorff, his second-in-command and an experienced marketing executive with a background at Visa USA and Coca-Cola. Razzouk retained the nominal title of chairman, but had stopped commuting to the Bay Area from his home base in Memphis before he completely severed his ties to the dot-com at the beginning of August to join the local venture capital firm Paradigm Capital Partners.

There's no question that Razzouk built a big company, even if it was shaky, within the span of one year. He pumped up an obscure Internet startup with a half-dozen employees into a major market contender with a workforce of 460 people - including a large staff of licensed pharmacists who manned a 24-hour operation at the company's state-of-the-art computerized distribution center. Problem was, too little attention was paid to business fundamentals, analysts say, and the rapid growth proved unsustainable.

Contacted by telephone at his home in Memphis, Razzouk, who is known to most outsiders for his courtly Southern manners, was dignified and polite. But he declined to comment on the allegations about his abrasive management style or the reasons for his leaving PlanetRx. "I don't think I have anything to apologize for. What we did in such a short period of time was incredible," says Razzouk, who at last count owned 2 million PlanetRx shares. "It's a terrific company. I don't have anything negative to say about anyone there."

The string of marketing agreements he rushed to negotiate with strategic partners did not seem careless then, Razzouk contends. He and his financial backers on the board of directors apparently were acting on blind faith that an unstoppable Internet boom would allow them to grow greater and greater revenues that would theoretically lead to profits and eventually justify the exorbitant costs of hyping the brand. Everyone else seemed to be playing that game - including the money-burning juggernaut Amazon.com, a key partner to PlanetRx archrival Drugstore.com.

"If you look at the company in terms of the metrics of the time, it did what it said it was going to do, very successfully," says Razzouk, speaking with a hint of pride. "Now the rules have changed. I don't think a company can be criticized for doing what it told its investors and its customers it was going to do."



To understand PlanetRx's troubles, you need to dig deeper than the "Founding Story," located on its Web site. The story begins with a young medical student and his idea that patients would be better served if they could get help online managing their diseases and buy their prescription drugs on the Web instead of at drugstores. The student, Michael Bruner, was so excited about the possibilities he envisioned that he quit his studies at the University of Pennsylvania Medical School and moved to Northern California.

Bruner registered the domain name NetPharmacy and toiled out of his low-rent apartment in Berkeley, Calif., until he was able to solicit some meager seed money from friends and relatives and persuade two buddies from his undergraduate years at the University of
Michigan, Stephen Su and Randall Wong, to join his quest. In the spring of 1997, they opened a small office a few blocks away from Oakland's bay-front Jack London Square.

A sympathetic landlord kept them afloat by investing in the enterprise. He also introduced them to a friend who knew a young Harvard MBA with solid VC connections - Stephanie Schear Tilenius. Tilenius at first dismissed the startup as going nowhere, but a year later jumped on board and helped line up $5 million in first-round financing from two leading Silicon Valley venture capital firms, Benchmark Ventures and Sequoia Capital. Since NetPharmacy sounded too generic, not like a cool Internet brand, they racked their brains for a better name, settling on PlanetRx.

Razzouk joined the firm in late 1988. Before that, he had had trouble at another Internet firm, America Online. AOL hired Razzouk as president and chief operating officer from FedEx in 1996. It's an example of an early trend among dot-coms that sought experienced managers to provide maturity and stability to young companies. But AOL and Razzouk were apparently not suited for each other, and he left after only four months on the job.

His stint at AOL was well documented in the popular 1998 book AOL.com by Kara Swisher, a business journalist for the Washington Post. At AOL, Swisher wrote, Razzouk was notorious for his "finicky attention to minor details" - a criticism that PlanetRx employees would later repeat.

David Beirne, now a star on the Silicon Valley venture capital scene, had recruited Razzouk for the AOL job when he was with Ossining, N.Y.-based executive search firm Ramsey/Beirne Associates. Beirne had made a name for himself as the plucky young headhunter who snared Jim Barksdale from AT&T Wireless and brought him to Netscape. Beirne arrived at Benchmark Capital in 1997 and would become one of PlanetRx's two principal backers along with Michael Moritz of Sequoia Capital.

Beirne brought Razzouk to PlanetRx after the executive's short run at AOL. When asked point blank why he recruited Razzouk for PlanetRx, he fired back an angry e-mail fusillade, and then would only say: "It is really hard to blame any one person for the situation at "PlanetRx" ... "pharmacy benefits managers", market, e-tailing, management, etc."



Critics of Razzouk at PlanetRx say he squandered time and energy on minutia in the name of instilling corporate discipline. For example, Razzouk went to the extraordinary expense of hiring a prestigious San Francisco law firm to sue a subtenant at the company's former site in Oakland, only to drop the suit without collecting a dime.

One senior executive at PlanetRx says of Razzouk: "He was certainly gruff and harsh. But when you got to know him he was a paper tiger, all bluster." In an early incident that's now part of the lore inside PlanetRx, Razzouk is said to have screamed and excoriated Su, a company founder, when the telephone system briefly went dead during the company's move to South San Francisco in January 1999. Su, a chemical engineer with a doctorate from the University of
California at Berkeley, suffered the tirade in silence. He quit this spring and declined to comment on the incident.

Bad blood soon developed between Razzouk and founder Michael Bruner, who at one point found himself banished from the head office to the distribution center in Memphis. Although Bruner is a significant shareholder and remains on the payroll, he no longer reports to work. Friends say Bruner lives in Berkeley, but he did not reply to messages left on his voicemail.

Su and co-founder Wong had other reasons to be unhappy. They believed they got short shrift in the initial stock allocations when the company was incorporated in September 1998, receiving only half a million shares each - or one-quarter of what Bruner, Tilenius and Razzouk negotiated for themselves. Benchmark and Sequoia each took 20 percent of outstanding stock, giving them a controlling voting block. One early investor recalls being astonished by the way the startup had been carved up. "There was never an alliance in this deal "among founders and management"," says the investor, who spoke on the condition of anonymity.

Tension within the ranks didn't make it any easier for Razzouk to prepare his company for intense competition in one of the most profitable market sectors in the health care industry. The company's nemesis, Drugstore.com, was rising menacingly in the Seattle area, funded by Kleiner Perkins Caufield & Byers - and backed by Amazon.com with a 29 percent stake.

Razzouk's new management team wasted no time in the unavoidably chaotic business of getting its operation off the ground. Contract engineers from the Internet consulting firm Scient, where Beirne is a major investor and director, had already begun constructing the architecture for an online retailing platform on the scale necessary to compete. PlanetRx blasted onto the Web on March 18, 1999, just six months after the major investors arrived on the scene - and, more significantly, 21 days after Drugstore.com opened its site for business.

Only after PlanetRx's successful Web site launch did the company get around to hiring a chief financial officer, followed by frenetic preparations for the initial public offering. Throughout this period, Razzouk and Tilenius, now senior VP for business development, were furiously lining up the kinds of marketing alliances they believed would give them better competitive footing against Drugstore.com, whose strategic alliance with Amazon.com would eventually put it in a powerful position.

In January 1999 Razzouk teamed up with AOL again. He signed off on a three-year agreement costing PlanetRx $15 million for the privilege of being the "premier online pharmacy partner" on AOL's Health and Women's channels. Other merchandising and marketing agreements were hammered out that spring with Women.com and Yahoo, propelled by a $50 million second round of VC funding in July. Then in September PlanetRx made an equity deal with iVillage.com, a women-oriented shopping site, that involved $22.5 million in marketing fees.

PlanetRx has not disclosed whether any of these deals paid off, either with more traffic or sales boosts. But PlanetRx's urgent efforts in April of this year to renegotiate marketing alliances it had formed with most of its partners was evidence that the arrangements were painfully siphoning off an excessive amount of its cash. The company had spent nearly $100 million on marketing and sales during a one-year period ending in June while generating net revenues of only $26 million. If it would be any consolation, Drugstore.com struck a monster $105 million co-branding deal with equity partner Amazon.com at the beginning of this year - before the bottom fell out for e-commerce stocks. By that time, however, Drugstore.com's coffers were full, having raised some $200 million in financing, an amount it would supplement with a healthy $62 million private placement at the end of July.



In their pre-IPO rush to market, neither company paid enough attention to one of the most important hurdles to the prescription drug market. They needed to line up PBMs - the big companies that have a lock on the prescription drug market through contractual relationships with medical insurers. Securities analysts say both companies were told by institutional investors they could not make a public offering without first solving this problem.

This is where PlanetRx made a crucial mistake. One road to the PBMs was through the major drugstore chains, CVS, Rite Aid and Walgreens, which recognized the importance of having a presence online and could bring to an Internet partner their various PBM connections. Rite Aid, with 3,800 stores in its chain, had the strategic advantage of having a PBM as a wholly owned subsidiary, PCS Health Systems, which managed prescriptions for 50 million insurance beneficiaries. PlanetRx execs entered into discussions with Rite Aid but were apparently unhappy with the terms, and nothing materialized.

Within a matter of weeks, Rite Aid signed an equity investment and partnership transaction with Drugstore.com, solving that company's PBM problem. The deal also gave it a click-and-mortar alliance with a major retail chain, which industry analysts say is essential to survival in the sector - the kind of alliance PlanetRx has not been able to successfully negotiate to date.

Partnering with a PBM, it should be noted, has not turned out to be the panacea that the online pharmacies had hoped for. Alliances between the two worlds have built-in conflicts. Pharmacy benefit managers have good reasons not to give away too much of the lucre in the drug prescription pie, which they currently control through relationships with conventional drug retailers and their own direct-mail sales operations.

Razzouk, however, was under pressure to quickly cut a deal with a suitable PBM partner after Drugstore.com's impressive IPO at the end of July. Its shares, offered at $18, soared 179 percent to more than $50 in its first day of trading, giving the company a market capitalization of $2.1 billion. About a month earlier, the company had been valued at $30 million, when Rite Aid paid $7.6 million for a 25 percent stake in the Internet pharmacy.

Within a week of Drugstore.com's IPO, PlanetRx announced its partnership with Express Scripts, the nation's third-largest PBM, structuring a deal that analysts would later consider rash. The five-year agreement gave Express Scripts a 19.9 percent post-IPO equity stake in PlanetRx, and at the same time obligated PlanetRx to pay the PBM $14.6 million or more each year in fees - more than its annual revenues at the time - for vaguely defined marketing services and the privilege of being the PBM's exclusive online pharmacy. By the time PlanetRx pulled off its IPO in early October - 10 weeks behind Drugstore.com - it was already clear that it was losing the race. The word among investors was that the lack of a partnership with a drugstore chain would ultimately harm its competitive position. The stock was offered at $16 and rose 62 percent on the first day of trading to $26, making the company worth $1.32 billion. Not a bad valuation, but it was nearly half that of its archrival.

In the ensuing months, PlanetRx would continue to flounder in a desperate attempt to catch up with Drugstore.com before its weaknesses were revealed in the recent layoffs and management shakeup.

"Since I've been here, the sense is that we've already won the race," says Drugstore.com VP for Strategic Relationships Judith McGarry. "PlanetRx has not been considered a significant threat to our business."

Now, with its penny stock in the pits and Drugstore.com's share hovering in a relatively more respectable $5-to-$6 range, PlanetRx is coming out of denial. "The hype is going in the opposite direction. It's a pendulum swing," says Tilenius. "You can't just shrug it off, because it limits your ability to raise capital. But if forces you to focus on sustainable growth."



Despite the gloomy outlook, PlanetRx has a few things going for it that could help its future once it cuts its burn rate in half by retrenching operations in Memphis and laying off 50 employees. It has a passel of satellite sites such as Alzheimers.com, Breastcancer.com, Depression.com and Diabetes.com. A person who suffers from chronic illnesses and searches the Internet for information is likely to be directed through a search engine to one of PlanetRx's sites, which provide focused content and sell disease-specific products.

The strategic edge here for PlanetRx goes back to founder Mike Bruner's original thinking. He imagined the Internet becoming an interactive tool that could do things like remind patients, particularly the chronically ill, to take their medication. Neighborhood druggists don't phone patients when they fail to come in to refill their prescription, but PlanetRx's chronic-illness sites send e-mail to regular customers. Chronically ill patients, who are responsible for about half of all prescription drug sales, are the bread and butter of Net pharmacies.

"When a patient leaves the doctor's office with a prescription in hand, there's very little further contact. That's the end of the story," says Elizabeth W. Boehm, an analyst at Forrester Research who tracks Internet drug commerce. "The Internet can do very well to remind patients to comply, and explain the medication they're taking and help them stay with the course." Total sales of prescription drugs online last year was a mere $160 million, but Boehm believes this will grow to $15 billion within five years. Another prominent health care analyst, Claudine Singer of Jupiter Communications, projects a more modest $4.4 billion sales figure for online prescription drug sales in 2004.



PlanetRx is not the only Internet pharmacy reminding its customers to replenish their orders, but it goes a step further by selling sponsorships for its chronic-illness satellite-sites to pharmaceutical manufacturers. Sponsorships accounted for 12 percent of total revenues in the first half of this year, but the program raises some ethical questions, particularly whether the sponsor might exert influence over editorial content on the sites. This issue came to a head earlier this year when Parke-Davis, the exclusive sponsor of Diabetes.com, was forced by the Food and Drug Administration to withdraw its popular drug Rezulin from the market because of widespread evidence that it caused fatal liver damage.

As part of the sponsorship, PlanetRx was the online vendor for Parke-Davis' "Rezulin Express" program, which made the drug available at discounted prices to diabetics without health insurance coverage - a good source of hard cash without the hassles of PBM authorization. Following disease state management protocol, customers were given free testing of their liver function and their blood sugar trends. But health care information on the site apparently did not mention the controversy over the drug's side effects beyond what Parke-Davis disclosed under FDA guidance. Diabetes.com did run a story mentioning the controversy - but did not mention the 58 deaths attributed to Rezulin - shortly before the drug was taken off the market in March. Matthew Naythons, vice president in charge of editorial operations at PlanetRx, insists that in-depth stories were posted on the site last year, but a search of the archives revealed no trace of them.

It was Naythons, a former emergency room physician and freelance photojournalist, who brought the basket of disease-specific domain names with him when he joined PlanetRx at the beginning of last year. Naythons says he's tried to instill integrity in the editorial content, and rejects the possibility that the Parke-Davis sponsorship might have affected coverage on the site. "It's key to our credibility. We feel sponsorship is important - it's a revenue source. But that's a pharmacy promotion that has nothing to do with editorial."

The Parke-Davis sponsorship, however, did not go unnoticed by PlanetRx's competitors. "PlanetRx's content strategy was to try to be both church and state," says Drugstore.com's McGarry. "I think the consumer in that sort of situation feels compromised."



How long can PlanetRx, or any of its competitors, stay alive? The popular site boasts a customer base of more than one million shoppers and it sold $16 million in goods during the first half of this year, with more than half of that from prescription drug sales. Drugstore.com reported net sales of $47 million during the same period, but a straight comparison is difficult to make because Drugstore.com can claim the sales volume of orders it processes but does not fulfill or ship orders for its brick-and-mortar partner Rite Aid.

PlanetRx's financing is burning up at an accelerating pace; its $78 million in net losses during the second half of 1999 has deteriorated by 20 percent to $94 million for the first six months of this year on $18 million in sales and sponsorships for the period - a miserable performance even if it isn't entirely out of proportion with other imploding Internet retailers. In contrast, Drugstore.com's burn rate appears to be relatively tame. Its net losses of $104 million for the first half of the year were only slightly more than twice the revenues it claimed.

PlanetRx is now up for sale, and in the absence of a buyer its near-term prognosis of survival, security analysts say, is fair - but only because it got an emergency cash infusion at the end of July. This $50 million line of credit put together by Alpha Venture Capital is tied, they note, to the precarious performance of the company's stock, which peaked in value following its IPO last October at $36.50, but was trading as low as 50 cents a share in early August. (The share price rose to 72 cents on news of the company's plans to consolidate operations in Memphis). The new line of credit is "an encouraging first step, which buys them more time," says Caren Taylor, a health care analyst at online investment bank E-Offering. "At their current burn rate, it gets them through the third quarter of next year if they watch their expenses."

That's the task of newly appointed CEO Beindorff. Beindorff moved to the hot seat in April with the urgent task of restructuring the house that Razzouk built, renegotiating the operation's costly business alliances, slashing its marketing budget and laying off 15 percent of its employees. But he downplays the likelihood of a takeover, saying the goal was to survive by becoming lean and efficient. "We're trying to look at everything we can do to be more productive without spending so much money," he says.

PlanetRx's woes, more than anything else, illustrate the extraordinary difficulties encountered by Internet players poaching on the lucrative turf of the entrenched health care industry. It may be that survival for the likes of PlanetRx hinges mostly on improving its position with PBMs. Since PBMs control the contracts with big insurance companies, they also dominate highly profitable volume market of filling prescriptions for three-month supplies of medication - the holy grail in the drug trade. This business would be a natural for one-click transactions on the Internet, except that the PBMs are limiting it to their own direct-mail-order operations. They don't need to squander tens of millions of dollars in marketing and brand promotion to do this business, and they can't be expected to give up it up to their Internet partners.

PlanetRx's prognosis is poor and its days are numbered, unless it can come up with a come up with a new plan of attack.

 
Karl Schoenberger is a contributing writer for The Standard and author of a new book about corporate social responsibility, Levi's Children: Coming to Terms with Human Rights in the Global Marketplace (Atlantic Monthly Press).