(FORTUNE Magazine) – Two months ago, at a health-care conference in San Francisco, Drugstore.com CEO Peter Neupert stood before a room crowded with Wall Street analysts and investors and talked about all the problems with traditional brick-and-mortar drugstores. "People have lots of questions, like 'Which of the ten St. John's Wort products should I take?' and 'Should I even take St. John's Wort?' Retail stores just aren't set up to answer those questions," said Neupert, whose Bellevue, Wash., Internet startup is less than one year old. "I mean, the individual pharmacists aren't there to answer your questions, and you're not going to ask the store clerk, who has zero education and has probably been working there for eight weeks." One month earlier he had appeared on the Today show with Internet superstar Jeff Bezos, CEO of Amazon.com. Amazon is Neupert's largest investor, and Bezos seemed to hold the corner drugstore in equal disdain. "People don't like to browse the drugstore. You don't exactly browse the Preparation H aisle," Bezos giggled to Maria Shriver.

In both cases, the message was clear--the corner drugstore's a disaster, and the Web is here to make everything all better. Thank God for the Internet, and watch out, you lazy brick-and-mortar types!

Then the unthinkable happened. On June 22, Drugstore.com announced that it had entered into a grand partnership--with Rite Aid, a brick-and-mortar retail chain with thousands of those terrible, annoying, hidebound drugstores. Drugstore.com sold Rite Aid 25.3% of its stock for $7.6 million and sold another 8% for $2.4 million to GNC, a Rite Aid partner that sells vitamins and nutritional supplements. Drugstore.com will offer online shoppers the option of ordering prescription drugs on the Web and then picking them up at a local Rite Aid. Rite Aid, meanwhile, will promote Drugstore.com in its 3,800 stores nationwide and link to Drugstore.com on its Website. Rite Aid will also make Drugstore.com the online drugstore of choice for PCS, its pharmacy-benefits management (PBM) division that serves 50 million people whose prescription drugs are covered by corporate health plans.

But wait. Wasn't Neupert's startup supposed to "Amazon" retail pharmacies? Wasn't his central promise that Drugstore.com was "eliminating a trip to the drugstore"? Wasn't the corner drugstore expensive to build, inconvenient to shop at, impossible to staff with qualified personnel, and, therefore, toast?

Well, sure.

The fact is that despite the inexorable logic of the Internet--eliminate the middleman, let efficiency rule--there are times when the real world will not concede gracefully, when the roadblocks it places in the way of technology and progress and all that are simply too strong to push aside. This is one of those cases, and that's why Drugstore.com had to join forces with Rite Aid. The two sides approached the e-commerce market from radically different positions, one with trepidation, the other with exuberant anticipation and confidence, and collided. This is the story of why their alliance was the only rational conclusion.

Over the past year, as the noise of online drugstores being developed in Silicon Valley and Seattle has grown louder, brick-and-mortar retail chains like Walgreens and Rite Aid have started thinking about the Web. Slowly. CVS was the first to act, making its move a month and a half ago, when it acquired the Internet startup Soma.com in Seattle for $30 million. But CVS still has lots of work ahead. Soma was actually the first online drugstore to launch, but its Website is listless and lacks the expansive product selection of its competitors.

Walgreens and Rite Aid, meanwhile, could bring themselves to nothing more than bargain-basement ventures. Literally. In mid-February, Rite Aid CEO Martin Grass plucked Kent Whiting, 39, from his post as the company's CIO and put him in charge of the company's Internet strategy. Grass gave the 13-year Rite Aid veteran the task of figuring out how the chain should respond to the threat of online drugstores. So Whiting took to the basement of his Harrisburg, Pa., home, where he has a Gateway PC with a 56K modem, and started clicking around the Web drugstores being developed by techies 3,000 miles away. After two weeks of self-confinement, Whiting emerged with a business plan for Rite Aid's full-service online drugstore. That was in March. Three months later, Rite Aid had made no significant hires for its Web effort, and www.riteaid.com offers little more than the ability to schedule in-store pickup of prescription refills and the kind of information you might find in a corporate brochure.

That's fine with Whiting. While Rite Aid knew it had to do something online, it could never make sense of the numbers. "If you sell a tube of toothpaste online for $2.29, and I'm going to pay $2 to have it shipped," says Whiting, "that's not a business model." Furthermore, he adds, "Joe Six-pack is not buying things on the Internet. There's a large component of people who still shop in stores, and I don't expect them to change overnight. It's not like 70-year-old grandmothers are going to wake up one morning and get on the Web because they think they can't live without it."

People at the two leading online drugstores, PlanetRx.com in South San Francisco and Drugstore.com, just outside Seattle, operate with a slightly different sense of urgency. In late April, when I visited with Drugstore.com's Neupert at his cramped startup offices in Redmond, Wash., he was trying to recall how many people worked for him. "It's 170, I think," he said. "No, wait, this week it's 185," he guessed. By the time I talked to him again in mid-June, he'd moved the now 245-employee company into bigger offices in Bellevue, several exits down the freeway, and added hundreds more products and a handful of new features to the 11-month-old company's Website. He'd also filed for an IPO less than two months after his launch. By comparison, Amazon.com took almost twice that time to get to the same number of employees and had been around for a full three years before it attempted a run at the public markets.

Whiting's insouciance is especially astounding when you consider that never before has a race to colonize a new market on the Internet been quite so fast or furious. At first glance, it seems that the brick-and-mortar chains must have been willfully ignoring the potential. Start with the sheer size of the drugstore market: Americans spend four times as much annually on products sold in drugstores as they do on books and CDs combined. Four out of five visits to the doctor result in a prescription's being written, one reason that last year prescription drugs alone accounted for sales of $101 billion. By 2002 that number is expected to balloon to $143 billion. Then there's a $16-billion-a-year market for over-the-counter medicines, a $36 billion market for beauty and personal-care products, and a rapidly growing $11 billion market for vitamins, supplements, and alternative remedies.

Drugstore and PlanetRx expect big chunks of that $164 billion in annual sales to move online. And why shouldn't they? People enjoy browsing through a bookstore or record store, but as Neupert will be the first to tell you, nobody really likes going to the drugstore. There are no hot, foamy lattes, literary classics, or listening stations. Just lots of slow lines, surly, enervated cashiers, and pharmacists who are often too busy counting pills into bottles to answer your questions. When you add in such pleasures as buying tampons, condoms, and wart cream in person, Neupert's promise--"We're eliminating a trip to the drugstore"--does sound pretty appealing.

Besides, if Neupert delivers and makes your life a lot easier, he's got a good chance of scoring you as a customer for life. Just as Amazon.com learns your reading and listening preferences, online drug sites can easily learn your health habits; in fact, you help the sites along when you order prescriptions, coughing up information about your health condition and various medications you may be taking. The info enables the sites to offer you relevant medical content, cross-check your drugs to ensure there are no dangerous interactions, and provide other customer-friendly services like e-mail reminders for prescription refills and subscription delivery of over-the-counter drugs and sundries you need on a regular basis. Once you've gone to the trouble of inputting your health data at one site, why go through the bother of doing it somewhere else?

The persuasive logic of all this was first understood by Netheads, not by the traditional purveyors of drugs. The speed with which Silicon Valley's movers and shakers moved and shook once they grasped it is the reason the Internet startups are so far in the lead now. In May 1998, John Doerr of Kleiner Perkins Caufield & Byers called Neupert, then a VP in Microsoft's interactive media group, and asked him to be CEO of a Website that Kleiner was about to fund, one that would play in a market far bigger than any other consumer e-commerce category to date. Even though Jed Smith, now VP of strategic partnerships, had dreamed up the idea just three months before, Kleiner had already lined up an investment of $4 million from Jeff Bezos' Amazon.com, another company KP had funded. (That investment has since ballooned to $35 million.) After some hemming and hawing, and after Doerr had introduced him to a collection of Kleiner's Internet CEOs, Neupert signed on in July. The site launched in late February, with a press breakfast in KP's Menlo Park offices, at which Bezos casually dropped the bomb that, oh, by the way, Amazon.com had bought 46% of the new company. Neupert, Doerr, Bezos, and board member Howard Schultz, CEO of Starbucks, all wore bright-purple ties, toasting the company's official color. Suzan Fine DelBene, Drugstore's vice president of marketing, wore a purple scarf. Journalists scribbled with purple pens.

The network moved just as quickly for PlanetRx. Last August, Dave Beirne, in his offices at Benchmark Capital, just one stoplight down Menlo Park's Sand Hill Road from Doerr's office at KP, placed a call to Bill Razzouk. Beirne was getting ready to fund PlanetRx, a company started by Stephanie Schear of Intel and Michael Bruner, a medical student at the University of Pennsylvania. Like Doerr, Beirne wanted an experienced manager to run his startup, and the guy he wanted was Razzouk, a 13-year veteran of FedEx whom Beirne had recruited into a short-lived stint as COO of AOL. And like Doerr, Beirne had quickly lined up big-time supporters in just a couple of months, including venture capital firm Sequoia and later Christos Cotsakos, the CEO of E*Trade, who had agreed to serve as a board member. Unlike Neupert, Razzouk needed little persuading. He abandoned an offer from another Silicon Valley Internet company. By mid-September he had moved to San Francisco from Memphis and was proudly handing out his PlanetRx business cards. Razzouk launched in mid-March, with much less fanfare than Drugstore.com. There were no launch-day bagels and muffins for the media. Who'd want to show up at a shindig for the second online drugstore to launch in a month, anyway?

All in all, it seemed just one more headlong rush to Internet riches--until early this year. That's when Neupert, Razzouk, and Soma founder and CEO Tom Pigott started receiving letters from pharmacy-benefits management companies, like Rite Aid's PCS. The PBMs notified the Websites that their pharmacy contracts had been terminated "without cause." The rush to riches had crashed into a brick wall.

Pharmacy-benefits management companies are the stealth giants of the health insurance industry. Besides PCS, there are four other leaders--Express Scripts, Caremark, Advance Paradigm, and Merck-Medco, which is owned by the huge drug manufacturer Merck. Together the five represent more than 175 million people, or some 80% of the U.S. population having insurance coverage. Why are the PBMs so unfamiliar? Because their millions and millions of members encounter them only indirectly--through their employer or HMO, which contracts with the PBM to process prescription insurance claims.

Early on, Drugstore, PlanetRx, and Soma had all quietly slipped into the PBM networks by filling out standard paperwork. They had good reason to want in. When people fill a prescription at a pharmacy covered by their PBM, they typically pay a $5 or $10 co-payment. But if they go outside the network, they pay much more. Lose PBM approval, then, and you lose millions of customers. I recently asked PlanetRx's Razzouk how many "lives" he covers. Earlier he'd told me, and everyone else who asked, 70 million. Now he simply replied, "Not enough."

Without a PBM, Razzouk's online drugstore has a big problem. It can probably eke out a profit selling toiletries, beauty products, vitamins, over-the-counter medicines, and lots of prescriptions for Viagra, Propecia, and other "lifestyle drugs" that health plans typically don't cover. But without the ability to fill all of a customer's prescriptions, everything falls apart. The promise of being able to offer topflight customer service falls apart, because you're not a one-stop shop for consumers' health needs. Without getting prescription-drug orders, you can't screen for interactions, send e-mail refill reminders, or do many of the other things that might persuade a customer to log on rather than drive to the local Walgreens. The economics of the business fall apart, because you spend precious marketing and promotional dollars to attract online shoppers to your Website, only to have them discover they can't get their prescriptions covered. Your IPO may even fall apart, because you can't provide assurances that you'll be allowed into the prescription drug market, that $101-billion-a-year gold mine you were hoping would impress investors. The thought of all this makes Razzouk apoplectic. "This is the greatest game of liar's poker that's ever been played," he steams. "What they [the PBMs] are doing is totally anticonsumer and antichoice, and that's not at all what the Internet is about."

The thing is, the health-care industry doesn't seem to care that it may be interfering with "what the Internet is about." Razzouk and Neupert have been asking large employers and HMOs to pressure the PBMs to let members fill prescriptions at PlanetRx and Drugstore.com. But so far, the Net startups haven't won any converts: Health-plan administrators think it should be cheaper and easier to have all their online prescriptions come from one company, and if that's a dot.com belonging to their existing PBM, fine. "I've never received a single call from a benefit manager asking me to add Drugstore.com or PlanetRx to our network," insists Gregg Rotenberg of Express Scripts.

The 33-year-old is president of the newly created Internet division of Express Scripts, a $3.4-billion-a-year PBM in St. Louis, the country's third largest. Rotenberg's title helps explain why most PBMs want Drugstore.com and PlanetRx off their networks. If consumers decide to go online to order prescriptions, the PBMs want that business for themselves. In Rotenberg's case, this means creating a site called YourPharmacy.com, which soon after its June 28 debut will be the exclusive online drugstore on corporate intranets and HMO Websites, serving 47 million people covered by 10,000 different health plans.

Unlike Whiting, Rotenberg tries to operate on Internet time. "I feel like we're right about here," he said, holding his hand a few inches above the table where we were sitting at E-Healthcare World, an industry conference in Chicago in May. "This market is like one of those garage doors that you shut automatically. I'm just trying to run out before the door clamps shut." Despite Express Scripts' being headquartered in St. Louis, Rotenberg is doing his best to give YourPharmacy the look and feel of an Internet startup. Since Internet types won't exactly flock to Missouri, he's relocating the bulk of YourPharmacy's executive team and marketing and technical staffs from a drowsy St. Louis suburb to an office in Silicon Valley. He has also managed to snare a techie from a thriving Internet company to be YourPharmacy's chief technical officer--Tim Fleming, vice president of product development at E*Trade. He's even ordered up a big stack of denim shirts with the YourPharmacy logo emblazoned on the front pocket, standard fashion issue for any self-important tech company.

Rotenberg is closely studying his Net competitors. Every day James Gardner, YourPharmacy's vice president of marketing, logs on to Drugstore and PlanetRx and prints out key screens to circulate among the YourPharmacy staff. Rotenberg realizes he needs to have the same 17,000-plus products for sale at the same cheap prices, all organized in easy-to-navigate categories. He knows he needs to link those products to reams of useful content about thousands of prescription drugs and practically every health ailment known to man--content he's already got up on a tandem site called DrugDigest.org. And he needs a round-the-clock team of chirpy customer-service reps, as well as pharmacists who'll answer within 24 hours any question customers care to ask.

If he can do all that and keep doing it--continually adding lots of new features and products--Rotenberg may really win big, because Express Scripts' HMO customers will find little reason to ever migrate to another online pharmacy. But Neupert, for one, gives him little chance. "How are they going to invest at the level I or PlanetRx have been investing and do as good a job? It's not easy," he cautions. "They're going to have a tough time getting top technical talent. I mean, why would anybody ever go work for Express Scripts?"

The truly astonishing thing about Neupert is that despite selling 25% of his company to a brick-and-mortar chain--something he never envisioned when he took the job at Drugstore.com--he has lost none of the Web-will-change-everything hubris that has helped make Drugstore.com the online leader in just 11 months. It's a brazen attitude, because as he was thrusting toward an IPO, a consensus emerged among industry analysts that Drugstore.com would be nothing without an offline, real-world partner.

In a report issued in June, Evie Black Dykema of Forrester Research predicted that the ultimate winner of the online drugstore war wouldn't be one of the "pure plays," as she called them. The more likely champion would be either one of the brick-and-mortar chains or a PBM. Says Dykema: "Without covered lives, online pharmacies are a house of cards, because nobody's going to buy prescriptions that aren't covered." Around Forrester's Cambridge, Mass., offices, the running joke was "Drugstore.toast."

Mark Husson, who covers drugstore stocks for Merrill Lynch, has been even more emphatic in reports he has written entitled "Why the Dot Coms Don't Matter" and "Why Dot Coms Need Bricks." In Husson's estimation, online drugstores differ from other e-commerce plays because they operate in what he calls an acute market. The dot.com pure plays, he explains, will never be able to replace the corner drugstore when you're sick and need something right away--a situation that accounts for 20% to 30% of drugstore purchases. When your arm blows up with poison ivy, you're not going to order calamine lotion from the Web and then wait a couple of days for it to show.

Whiting points out that this isn't the only advantage his brick-and-mortar chain brings to Neupert's Website. There's marketing muscle--Rite Aid can promote Drugstore.com on bags and cash register receipts in its 3,800 stores and in national radio and TV ads. There are the existing Rite Aid customers who are already using the company's Website to schedule some 45,000 prescription refills a month for in-store pick up. And there's the brand name--more people know and trust Rite Aid than know and trust Drugstore.com. Given all that, says Husson, "when the large brick-and-mortars launch, they'll be able to do sales of $650,000 within a day and a half." That's the sales figure Drugstore.com reached after 38 days, as it reported in its IPO filing.

All this is part of what finally persuaded Neupert four weeks ago to turn ongoing, informal discussions into serious negotiations. It's nice for him that Drugstore.com customers can now order online and pick up their medicines in stores instead of waiting for the mail; this gives him entree into that "acute" market. Much more important, the Rite Aid deal gives him access to the 50 million consumers served by its PCS subsidiary.

Even now, though, Neupert sounds like a dyed-in-the-wool Net believer. He's got his 50 million lives, but he wants more. He wants full, unlimited access to all health plan members. He wants consumers to be able to choose which online drugstore they shop at. As things now stand, if the universe of consumers with insurance coverage were to come to Drugstore to get their prescriptions, he'd have to turn down more than half of them. "I hate it," he says. "Getting people to come to your site and then having to turn them away because the insurance industry isn't moving at Web speed is a real challenge." He and Razzouk abhor the entrenched thinking in this business. Neither CEO can understand why, for instance, health plan administrators would want to offer members a link to just one online drugstore on the corporate intranet. The administrators reason that since most HMO patients don't have full, covered access to any doctor or any hospital anytime they want, why should they need the right to choose which online pharmacy to patronize? "Yeah, why. Choice--what a concept," says Neupert sarcastically. "The consumer will win eventually, because that's what the Internet is about. And if you look at the way doctor networks have opened up lately, there's proof there."

Despite the crusading rhetoric, Neupert can't deny that there's a particularly delicious irony in his deal with Rite Aid. In its latest round of funding, which closed in May, Drugstore.com was valued at $433 million. Yet a few weeks later Neupert was willing to virtually give stock away to Rite Aid, selling at a price that seemed to suggest the company was worth just $30 million. Why? Because Neupert needed Rite Aid's 50 million consumers. Those millions of people now linked to Drugstore.com via Rite Aid's PCS subsidiary are incredibly attractive to Wall Street and IPO investor types, whose concerns had been mounting over the past few weeks. The deal reassures them that this KP-funded, Amazon-partnered company may well go out with a superstar, multibillion-dollar IPO, the kind of explosion that companies like eToys and Ariba enjoyed when they first offered their stock. With a highflying publicly traded stock, Drugstore.com can hire even more talented execs and gifted techies, market its site even more aggressively, and perhaps even buy other players in the health industry--like, say, a couple of midsized PBMs. Yup, Neupert owes his future riches, and his company's imminent financial strength, to a deal he cut with a decades-old brick-and-mortar company.

And what's in all this for that brick-and- mortar? Why did Rite Aid decide to hitch its fate to Drugstore.com rather than collect those potential online orders from its PCS customers for itself? Simple--it had little choice. Given his druthers, Whiting wouldn't have partnered at all. "If we didn't think that things were going to develop rapidly in the market, then we would want to control our own destiny 100%," says Whiting, who will cede most of the control of Rite Aid's e-commerce presence to Neupert. "In a perfect world, we'd hire all the people and create our own Website. But this isn't a perfect world. There's some fundamental insanity going on here. I hope people realize that."