Boots has made healthy but decreased profits, and its position is still enviable. But with the rising threat of own-label, stronger rivals, and loss-making companies in the group, it must defend its core business, while expanding into internat

When Boots reveals reduced annual pre-tax profits of between 490m and 500m tomorrow (Thursday) it will know that despite appearances, it faces a tough time ahead. The five per cent drop from 525m is the least of its concerns.

The proposed merger between the chemist groups Lloyds and UniChem will create an even more powerful rival. Own-label manufacturers and retailers are eating into some of its core market sectors. While its troubled DIY companies are expected to turn in losses again this year. The company is still searching for a European partner to develop new drugs, having sold its pharmaceutical business, and is expanding its international reach with investment likely to match the 70m spent in the past year.

In short, Boots is facing the difficult balancing act of defending its chemist empire in the UK while finding new markets for its international products and disposing of peripheral loss-making businesses.

Analysts predict pre-tax profits of 490m for the year ended March 1996, down from 525m for the year ended March 1995. But the view from the City is that they are still a healthy set of results and the lower profits reflect a shortfall as a consequence of the sale of its pharmaceuticals business to BASF in 1995 for 897m.

In the year to March 1995, the pharmaceutical business gener ated profits of 86.5m. This year that figure will be zero. Crucially, with the sale of its pharmaceutical division Boots lost its new product development capability, which is why it is now seeking a European partner for over-the-counter (otc) medicines. All Boots brands are now produced by Boots Contract Manufacturing.

Another significant figure in the annual results will be the 74m invested in the development, distribution and marketing of Boots Healthcare International – the international arm of the company’s UK otc business Crookes Healthcare. Last year the division, created in 1991 as a vehicle for global expansion, recorded a profit of 9.8m.

This year analysts expect a loss of 3m but see the 40 per cent hike in investment in BHI as an acceptance that Boots is over-dependent on the profits from its retail chemists. Boots the Chemist traditionally brings in 85 per cent of the group’s overall profits and will remain the jewel in the company’s crown. Pre-tax profits for the division are expected to be up more than ten per cent at 387m from 350m for the previous year.

The same analysts are recommending that Boots should move to a position where it is no more than 75 per cent dependent upon the 1,200-strong chain of chemists for its profits, as swiftly as possible.

Their reasoning is simple. The chemist empire stands to lose most from growing competition from own-label cosmetics and toiletries produced by the likes of Asda, Safeway, Sainsbury’s and the Kingfisher-owned Superdrug.

They have had little impact upon Boots’ market share to date. But some analysts argue it poses the greatest threat to Boots’ future operations and profitability.

Sainsbury’s has its own health and beauty products and both it and Safeway have recently launched own-label dental ranges. Superdrug has been refocusing its product range on health and beauty, redesigning its 720 stores and recruiting Steven Round as marketing director.

Asda is trying to increase its share of the health, beauty and otc medicines markets via price-cutting vitamins and campaigning for the abolition of the Resale Price Maintenance (RPM) agreement.

Although Asda began offering cut-price vitamins in 1995, this had little impact on sales through Boots the Chemist. According to a source at Boots, the company actually increased its share of the vitamins market as a result.

But if the review of the RPM by the Office of Fair Trading leads to the agreement being repealed, Boots will defend its position in otc medicines. “If it is abolished, we will compete in a deregulated market,” says a spokesman. “We are looking at an area where, in the past, grocers have taken us on on pricing – and in all cases where we have been challenged we have responded aggressively.” Product promotion and in-store activities are already on the agenda if the RPM is scrapped.

To reinforce its position, Boots is also operating a dual policy of UK shop openings with small community pharmacies supplemented by sites in out-of-town shopping malls. A target of 200 small community pharmacies within three years was agreed in August 1993; the company is opening these pharmacies at the rate of one a week.

Future shop openings, international plans and the defence of the pharmacy empire from rivals will all be on the agenda for a UK marketing strategy meeting in July (the first for three years) which will be addressed by new Boots the Chemist managing director Steve Russell. An announcement on the next phase of community chemist openings will follow the meeting.

Such a vigorous defence of its chemist empire is easy to understand as it accounts for 85 per cent of overall group profits. It also explains the intensity with which the company has pursued the introduction of new, innovative own-label products ranging from shampoo to skin care and aromatherapy oils.

Analysts say the company is looking to the chemist business to continue bringing in the lion’s share of profits, but via the domestic market, rather than international retail expansion. When asked, “does that not mean Boots plc is putting all its eggs into one basket?”, the response is that it is a very safe basket and one which delivers good results.

Despite this confidence in the chemist business, Boots plc needs to invest in its other companies. The growth potential in a sector already dominated by the company – health and beauty – is smaller than offered by its opticians, Halfords or contract manufacturing businesses. Its loss-making DIY companies are the exceptions to the rule.

One sector the company appears to have taken the City’s advice on is an expansion in its otc medicines.

BHI was created to focus on the global expansion of otc products, including Nurofen, Strepsils, Optrex and E45 (all manufactured by Boots Contract Manufacturing).

In the past year, 74m has been spent on the development and marketing of BHI’s international brands. Nurofen and Strepsils are, together, available in more than 130 countries and accounted for 55m of that spend with Nurofen receiving the bulk of the money. However, analysts still say these products need to be launched further afield. The company has no presence in the Pacific Rim, North America or Australia.

Pharmaceutical manufacturers have long realised that global exploitation of brands is the key to future growth. And the recruitment of key marketing staff in the past 12 months underlines BHI’s intention to launch products in new markets. Earlier this year, former Carlsberg-Tetley marketing director Liz Morgan was hired to market Boots otc brands both overseas and in the UK.

Strepsils and Nurofen are flagship brands for BHI. Strepsils, sold in 100 countries, is bigger by virtue of sales, but BHI sees Nurofen as the real flag carrier for the company, with greater long-term potential. The core Nurofen brand, available in 30 countries, is a major player in the analgesic market which is still expanding. Several line extensions, including Nurofen Plus and Nuroflex, have already been launched in Europe and there are others waiting to be introduced into fresh markets.

Turning these brands into international players is more than a viable option for BHI and one that is expected to deliver results in the form of long-term profits.

The sector has become increasingly crucial to drugs companies as pressure on healthcare budgets throughout the world is creating greater demand for otc drugs. To benefit BHI, brands must gain approval in these markets, and create distribution channels and build relationships with pharmacists and doctors. Acquiring new products, either by buying a European company – publicity over Boots’ search has inflated the price of potential suitors – or by licensing those already approved, will give it access to distribution but it will need major investment.

In the first half of its financial year to September 1995 BHI invested 32m in product launches, development and marketing support, a 24 per cent increase over the same period last year. In total, it spent over 70m in the financial year to March 1996, an increase of 20m on the previous year.

In addition to consolidating the chemist business and investing in the international marketing of BHI products, Boots must divest itself of some of its peripheral business, its 50 per cent stake in DIY chain Do It All being top of the list.

WH Smith, joint owner of Do It All, is preparing to sell its stake. Boots denies that it is about to follow suit, saying it is pursuing a strategy of closing down stores in poor locations in favour of refurbishing those in better locations. It is nevertheless understood that Boots is in fact preparing to sell all its loss-making DIY companies – Do It All, Fads and Homestyle – as a package.

An unexpected bonus has been the profits delivered by the properties business Boots formed in 1989. Last year, the business generated a 65m profit. Today the company is continuing to make use of its property assets by opening shopping centres and retail parks. Most recently, the company opened a 40m shopping centre in Harrow and will open another 50m site in Hastings next year. It uses the economic data it gets from its stores to make decisions on viable sites.

No one is accusing Boots of being complacent or resting on its laurels but the need to be pro-active, while defending its highly enviable position in the UK, will be even more vital as the company expands into global otc marketing and branding.

This year’s fall in profits may not have caused much concern in the City, but the reaction will be markedly different when the company’s investment in new markets continues to affect profits next year and the year after that. Boots needs to be bold and invest in its dual strategy of UK market domination and international expansion.

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