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Natural Selection
Can California startup Elephant Pharmacy really compete with the drugstore chains by selling herbs, potions, supplements—and even a few prescriptions?
By Ed Welles

(FORTUNE Small Business) – ELEPHANT PHARMACY Berkeley

OWNER: STUART SKORMAN KEY STRATEGY: Carefully catering to baby-boomers' style and tastes ANNUAL REVENUE: $11 million ANNUAL GROWTH RATE: 75% TOP RIVALS: CVS, Walgreen, Longs Drugs

Stuart Skorman has a penchant for sitting on the floor during meetings, contorting his frame like a yogi, and uncapping his black felt-tip pen to scrawl his latest spark of insight onto a wrinkled piece of scratch paper. Between founding companies—four so far—he has ridden his bike cross-country and spent a year and a half swimming with dolphins. He has meditated in monasteries and traded commodities. For two years Skorman even played professional poker. "You had to make decisions in seconds," says Skorman, 55, with a smile. "If you hesitated for a moment, your opponent knew exactly what you had. You had already lost."

Skorman's latest gamble puts him at a table where the other players have a lot more chips. He's going up against giant drugstore chains such as CVS, which recently acquired Eckerd's 1,200 stores, and Walgreen—the latter having sited three branches within a mile of Skorman's startup, Elephant Pharmacy in Berkeley. But Skorman is not worried about any chain beating up on his spacious, wood-toned, 10,000-square-foot store, which blends a traditional prescription department with herbal remedies and other alternative medicines, health-related books, upscale beauty products, organic foods, and flowers. "We've really invented a whole new model." he says.

Boosting the stakes, Skorman has launched his concept in the face of a merciless industry consolidation. Last year the top five chains accounted for 62% of total drugstore sales, up from 57% in 2002. Yet Skorman has plowed his entire net worth of $12 million into an effort to defy that obvious trend. "This could be the biggest mistake of my life—or my biggest opportunity," he says.

Lately it's been looking like the latter, since the novel concept has begun attracting competitors—as investors. Last May, Skorman raised $14 million from a half-dozen equity investors. Among them, surprisingly, is CVS, the country's largest drug chain, as well as the Saks Group, which will locate baby Elephants in 12 of its department stores (including Saks Fifth Avenue) to attract younger shoppers. Skorman says he plans to use the money and the credibility gained from those relationships to begin opening as many as 500 Elephant stores over the next decade—starting with two more outlets in Northern California in 2005.

The first Elephant Pharmacy—Skorman chose the animal because it is big and wise and projects a kindly image—opened in November 2002 and turned cash-flow-positive this past March. This year the company expects to generate sales of $11 million, up from $6.3 million in 2003, according to Elephant CFO Jenelle Mitchell, 41. Those numbers compare favorably with the $5.9 million in sales that the average drugstore rings up in a year, according to the trade journal Chain Drug Review.

But how representative of anyplace else is the Berkeley market? "The first and foremost challenge is that the bulk of homeopathic medicine does not appeal to the masses," says Michael Johnson, a senior writer with Drugstore News, also a trade publication. "Time will tell if Elephant Pharmacy can develop a critical mass."

Stuart Skorman is a wiry—and wired—man, fueled with rapid-fire energy. After two years of college, Skorman dropped out to manage a blues band, travel, and drive a cab. In 1977 he signed on as marketing manager with Bread & Circus, an upscale grocery store in Brookline, Mass. That startup, which was eventually sold to retailer Whole Foods, became a model for a new type of store, bringing natural foods into the gleaming aisles of mainstream supermarkets.

Skorman sees Whole Foods as a blueprint for Elephant in which an affluent slice of the population—concerned with health and attracted to products billed as herbal, natural, or organic—will pay more for quality, selection, and a little bit of theater in the aisles.

Taking a standard business and presenting it in a more thoughtful and appealing way is a trademark of Skorman's—as is risking all on the venture. In 1985, after leaving Bread & Circus, Skorman plowed his entire inheritance of $100,000 into the video business. The result was a six-store New England chain, Empire Video, which racked up the highest volumes per store in the country for three years running, according to Video Store Magazine. Skorman's strategy—now carried over to Elephant—was to sell not just products but information. Customers could read film reviews and find movies grouped not only by genre but also by theme and director.

In 1994, Skorman sold Empire to Blockbuster for $6 million. Two years later he would duplicate the feat, this time online, starting up video retailer Reel.com, which boasted 30,000 film titles. Skorman sold that business to Hollywood Video for $100 million in 1999. He netted $17 million from the deal, which he then invested in another online venture, Hungry Minds, a continuing-education portal. That went belly-up. "I lost $10 million, and my investors lost $20 million," Skorman recalls. Elephant has now swallowed what's left of his net worth.

Elephant Pharmacy doesn't look or even smell much like a regular drugstore. While the back of the store houses the customary counter for prescription drugs, Skorman has devoted just as much room to a warmly wood-paneled area that dispenses high-margin herbal remedies. The store's book section—which doubles as a reading room, with comfortable chairs—offers 2,500 titles. Bestselling subjects include massage, meditation, and yoga. Elephant also offers more than 100 free classes on-site each month on subjects ranging from Infant Massage and Communication to Ayurvedic Bliss Therapy.

Elephant is attracting a clientele of affluent, educated boomers who rely not only on doctors and prescription drugs to fix their ailments but also on megadoses of sea kelp and Siberian ginseng to forestall illness. Such customers, Skorman says, tend to visit Elephant more often than the typical drugstore customer, who comes in for a monthly refill of Lipitor.

The typical drugstore, explains Elephant CEO Dennis Zook, generates as much as 75% of its revenue from prescriptions. But given the clout of the big insurance companies, that business has ever-shrinking gross margins, usually less than 20%. The lower prices coming under Medicare's new drug benefit for seniors will only shrink that margin.

Moreover, it takes five years for a new drugstore to build its prescription business, because customers take their time in transferring prescriptions. "We've flipped that model," says Zook. Three-quarters of Elephant's business now comes from higher-margin nonprescription businesses. In areas such as gifts (Zen clocks, whose alarms sound like gongs, have been hot), videos, and health and beauty aids, gross margins approach 40%. Moreover, those "front of the store" businesses can be ramped to maturity in just three years.

Skorman has placed under one roof what amounts to 11 different businesses, including flowers, food, and photo processing, with each getting a twist to differentiate it from the typical CVS or Walgreen offering. Flowers are sold out on the sidewalk under an artful awning. Around big holidays, that stall can gross upwards of $10,000 a day. The food section offers organic produce and dairy products as well as frozen gourmet pizzas. That department cost a lot to put in, but it is a vital draw. "People don't shop for vitamins twice a week," says Skorman. They do for milk and eggs. As soon as he added food, customer traffic—leading through the food section and back into health and beauty aids, the most profitable area—nearly doubled. The heart of the store boasts a wide array of health and beauty products, many of them sporting such descriptions as "natural" and "organic." Those adjectives added to a label, confides Skorman, enable him to more or less double the price on the products. Skorman also invested twice the industry average in high-end photo-processing equipment and hired experienced technicians. The move attracted professional photographers willing to pay for top-quality work.

But with higher-quality goods and services—not to mention a finicky clientele—comes the need to staff the store with knowledgeable workers. Elephant has 80 employees, including herbalists and degree-holding specialists in Chinese medicine and homeopathy. The staff is friendly and well informed—hardly the usual slackers in smocks.

Labor costs at Elephant amount to 18% of gross sales, nearly double the figure for traditional chains, according to CEO Zook. Still, Elephant boasts a storewide gross margin of around 40%, well above the industry average of just below 30%. That average is under continuing pressure from Wal-Mart, which has pharmacies in more than 90% of its 3,500 stores. "Companies on the low end are getting slaughtered by Wal-Mart," says Skorman.

Skorman's two closest rivals, Walgreen and Longs Drugs, declined to comment on his venture. But David Pinto, editor of Chain Drug Review, suggests that Skorman may soon receive more attention from competitors than he would like. "They see it as an opportunity," he says. "It gives them ideas."

Potential competition is only one of the hurdles facing Skorman. Elephant must grow so fast that it will need to hire its own headhunter to find qualified herbalists and such in locations far from Berkeley. Another problem: securing enough capital to grow. Skorman says it takes about $3.5 million to get an Elephant store to the breakeven point. Multiply that by 500, and it's clear why, before he's done, Skorman could be severely diluted in favor of some deep-pocketed partners. And then, what are the chances that if Elephant takes off, they'll leave him alone and not try to either tell him what to do or, worse, gobble up his company?

Playing into such a scenario could be the wild card of Skorman's mercurial personality. Skorman admits that when it comes to running a business, "I need the stimulation, but I don't really want the responsibility." He likens being a CEO to performing a role in a play, which disciplines him to act within the confines of the part. "I can do it for up to three years, but not forever," he says. "I can't not be myself for too long." It all amounts to a delicate balancing act. Skorman has shown he knows how to ride one elephant. But it will be an entirely different challenge to breed and lead a herd of them.