Links Between Drug Company Profitability and Investments in Research: A Fact Sheet

Pharmaceutical companies must make a profit to stay in business. Some charge that drug companies make significantly more profits than companies in other industries. In fact, the profitability of drug companies is in line with other major industries. The research-based pharmaceutical industry also pays more taxes than other industries and reinvests more of its profits in research and development than other industries.


Prescription drugs are priced to reflect not only the costs of production, but also the significant costs of research and development. Recent research by the Tufts Center for the Study of Drug Development shows that the costs of developing a new drug exceed $800 million, with an average of 11 years from creation to market.


The profitability of drug companies is in line with other major industries.


? The average profit margin of the pharmaceutical companies in the Fortune 1000 list is 16% (profits as a percent of revenue). This is in line with the profit margins of the banking (13%), diversified financial (11%), tobacco (11%), and real estate (10%) industries (Fortune, 2002)1 . None of these industries has the need to pour money back into research that the pharmaceutical industry does.

? Drug industry returns have remained steady since 1981 at only 2 to 3% above the cost of capital (Little, 2002)2 .

? The pharmaceutical industry?s risk-adjusted return is actually lower than other R&D-intensive industries, such as computer network, equipment, and software services (Little, 2002).


And the pharmaceutical companies pay more taxes than most other companies.


? The pharmaceutical industry?s total tax liability (as a percent of income subject to U.S. tax) is 33.8%, which is slightly higher than for all manufacturing (33.7%) and for all industries (33.5%) (PhRMA, 7/17/00)3.

? The pharmaceutical industry pays more tax than 97% of all industries (PhRMA, 7/17/00).







The research-based pharmaceutical industry spends a significant percentage of its sales revenues on research and development.


? No other industry ? from electronics to telecommunications ? commits a higher percentage of sales revenues to new innovation and future advances (PhRMA, 2002)4.

? Whereas industry on average devotes just 3% of sales and export revenue to R&D, the pharmaceutical industry devotes more than 20% (PhRMA, 7/17/00).


There is a direct link between gross profitability and pharmaceutical R&D spending. As pharmaceutical companies make more money, they spend more on research.


? Over the last 40 years, gross profit margins and R&D outlays have mirrored one another, with a correlation coefficient of .92 (Scherer, 2001)5.

? Profits earned by a company serve as a source of funds to support R&D investments, and some managers set R&D budgets using current cash flow or sales as indicators (Scherer, 2001).


While it is true that some major drug companies have grown through mergers and acquisitions, no one company monopolizes the market. This is still a highly diversified industry where companies must compete.


? In 1999, no drug company had more than 6.5% of new approvals (DiMasi, 2001)6.

? There has been substantial turnover in the ranking of firms producing new drugs (DiMasi, 2001).


Continual investment in pharmaceutical research is important. Research shows new medicines are more effective at keeping people healthy, often avoiding other costly medical procedures and treatments. Generic drugs sometimes cost less, but they also may be less effective.


? For every $18 increase spent on new prescriptions, non-drug health care spending decreased by $71 (Lichtenberg, 2001)7.

? New drugs increase life expectancy and lifetime income, by about .75% to 1% each year (Lichtenberg, 2001).

? The use of new and more expensive drugs and other innovative technologies increases life span and productivity, and lowers overall health costs (Cutler and McClellan, 2001)8.


Recent proposals, including one by Senators John McCain and Charles Schumer, would accelerate the use of generics and erode patent protections in an attempt to keep drug prices down. The weakening of drug patent laws would stifle innovation and hurt research.


? 98% of doctors said patent rights were very or somewhat important as an incentive for drug production (Bandow, 5/17/02)9.


Generic manufacturers don?t have the research and development cost of brand name companies. Brand name pharmaceutical companies spent more than $30 billion last year on research for which they must recoup the cost to keep the new drug pipeline flowing. The current drug patent system, modernized by the Hatch-Waxman Act in 1984, provides companies with confidence that if they develop a successful and effective new medicine that they can recoup their investment and have the resources to develop new medicines.


The drug industry is just like any other industry. It is trying to turn a profit in an environment that is risky, constantly changing, and over-regulated.


For more information, please contact:

Grace-Marie Turner

703-299-8900

gracemarie@galen.org

1 Calculations based on the 2002 Fortune 500 Industry Rankings. ?How the Fortune 1000 Stack Up In Their Industries.? Fortune. April 15, 2002. http://www.fortune.com/lists/F500/indsnap_41.html

2?Examining the Relationship Between Pharmaceutical Pricing and Innovation.? Published by Arthur D. Little, Inc. on May 10, 2002. Available online at http://www.galen.org/news/PricingInnovationText.pdf

3?Taxing the Pharmaceutical Industry? PhRMA Backgrounder. July 17, 2000. Available online at http://www.phrma.org/publications/documents/backgrounders/2000-07-17.208.phtml

5 F.M. Scherer. ?The Link Between Gross Profitability and Pharmaceutical R&D Spending.? Health Affairs. 2001 Sep/Oct; 20(5):216-220.

6 Joseph A. DiMasi. ?Winners and Losers in New Drug Innovation.? Medical Marketing & Media. 2001 Sep; 36(9):99-110.

7 Frank R. Lichtenberg. ?Are the Benefits of Newer Drugs Worth Their Cost? Evidence From the 1996 MEPS.? Health Affairs. 2001 Sep/Oct; 20(5):241-251.

8 David M. Cutler and Mark McClellan. ?Is Technological Change In Medicine Worth It?? Health Affairs. Sep/Oct; 20(5):11-29.

9 Doug Bandow. ?Threatening Pharmaceutical Innovation.? The Washington Times. May 17, 2002.


SHARE THIS ARTICLE

About the author

Pharmaceutical companies must make a profit to stay in business. Some charge that drug companies make significantly more profits than companies in other industries. In fact, the profitability of drug companies is in line with other major industries. The research-based pharmaceutical industry also pays more taxes than other industries and reinvests more of its profits in research and development than other industries.


Prescription drugs are priced to reflect not only the costs of production, but also the significant costs of research and development. Recent research by the Tufts Center for the Study of Drug Development shows that the costs of developing a new drug exceed $800 million, with an average of 11 years from creation to market.


The profitability of drug companies is in line with other major industries.


? The average profit margin of the pharmaceutical companies in the Fortune 1000 list is 16% (profits as a percent of revenue). This is in line with the profit margins of the banking (13%), diversified financial (11%), tobacco (11%), and real estate (10%) industries (Fortune, 2002)1 . None of these industries has the need to pour money back into research that the pharmaceutical industry does.

? Drug industry returns have remained steady since 1981 at only 2 to 3% above the cost of capital (Little, 2002)2 .

? The pharmaceutical industry?s risk-adjusted return is actually lower than other R&D-intensive industries, such as computer network, equipment, and software services (Little, 2002).


And the pharmaceutical companies pay more taxes than most other companies.


? The pharmaceutical industry?s total tax liability (as a percent of income subject to U.S. tax) is 33.8%, which is slightly higher than for all manufacturing (33.7%) and for all industries (33.5%) (PhRMA, 7/17/00)3.

? The pharmaceutical industry pays more tax than 97% of all industries (PhRMA, 7/17/00).







The research-based pharmaceutical industry spends a significant percentage of its sales revenues on research and development.


? No other industry ? from electronics to telecommunications ? commits a higher percentage of sales revenues to new innovation and future advances (PhRMA, 2002)4.

? Whereas industry on average devotes just 3% of sales and export revenue to R&D, the pharmaceutical industry devotes more than 20% (PhRMA, 7/17/00).


There is a direct link between gross profitability and pharmaceutical R&D spending. As pharmaceutical companies make more money, they spend more on research.


? Over the last 40 years, gross profit margins and R&D outlays have mirrored one another, with a correlation coefficient of .92 (Scherer, 2001)5.

? Profits earned by a company serve as a source of funds to support R&D investments, and some managers set R&D budgets using current cash flow or sales as indicators (Scherer, 2001).


While it is true that some major drug companies have grown through mergers and acquisitions, no one company monopolizes the market. This is still a highly diversified industry where companies must compete.


? In 1999, no drug company had more than 6.5% of new approvals (DiMasi, 2001)6.

? There has been substantial turnover in the ranking of firms producing new drugs (DiMasi, 2001).


Continual investment in pharmaceutical research is important. Research shows new medicines are more effective at keeping people healthy, often avoiding other costly medical procedures and treatments. Generic drugs sometimes cost less, but they also may be less effective.


? For every $18 increase spent on new prescriptions, non-drug health care spending decreased by $71 (Lichtenberg, 2001)7.

? New drugs increase life expectancy and lifetime income, by about .75% to 1% each year (Lichtenberg, 2001).

? The use of new and more expensive drugs and other innovative technologies increases life span and productivity, and lowers overall health costs (Cutler and McClellan, 2001)8.


Recent proposals, including one by Senators John McCain and Charles Schumer, would accelerate the use of generics and erode patent protections in an attempt to keep drug prices down. The weakening of drug patent laws would stifle innovation and hurt research.


? 98% of doctors said patent rights were very or somewhat important as an incentive for drug production (Bandow, 5/17/02)9.


Generic manufacturers don?t have the research and development cost of brand name companies. Brand name pharmaceutical companies spent more than $30 billion last year on research for which they must recoup the cost to keep the new drug pipeline flowing. The current drug patent system, modernized by the Hatch-Waxman Act in 1984, provides companies with confidence that if they develop a successful and effective new medicine that they can recoup their investment and have the resources to develop new medicines.


The drug industry is just like any other industry. It is trying to turn a profit in an environment that is risky, constantly changing, and over-regulated.


For more information, please contact:

Grace-Marie Turner

703-299-8900

gracemarie@galen.org

1 Calculations based on the 2002 Fortune 500 Industry Rankings. ?How the Fortune 1000 Stack Up In Their Industries.? Fortune. April 15, 2002. http://www.fortune.com/lists/F500/indsnap_41.html

2?Examining the Relationship Between Pharmaceutical Pricing and Innovation.? Published by Arthur D. Little, Inc. on May 10, 2002. Available online at http://www.galen.org/news/PricingInnovationText.pdf

3?Taxing the Pharmaceutical Industry? PhRMA Backgrounder. July 17, 2000. Available online at http://www.phrma.org/publications/documents/backgrounders/2000-07-17.208.phtml

5 F.M. Scherer. ?The Link Between Gross Profitability and Pharmaceutical R&D Spending.? Health Affairs. 2001 Sep/Oct; 20(5):216-220.

6 Joseph A. DiMasi. ?Winners and Losers in New Drug Innovation.? Medical Marketing & Media. 2001 Sep; 36(9):99-110.

7 Frank R. Lichtenberg. ?Are the Benefits of Newer Drugs Worth Their Cost? Evidence From the 1996 MEPS.? Health Affairs. 2001 Sep/Oct; 20(5):241-251.

8 David M. Cutler and Mark McClellan. ?Is Technological Change In Medicine Worth It?? Health Affairs. Sep/Oct; 20(5):11-29.

9 Doug Bandow. ?Threatening Pharmaceutical Innovation.? The Washington Times. May 17, 2002.


SHARE THIS ARTICLE

About the author