We Need to Talk About Pharma Profits

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Brendan Shaw is principal at Shawview Consulting, a specialised consulting and advisory firm for public and private sector leaders in the areas of government-business relations, policy and strategic change, with a focus on the health and pharmaceutical sectors. He is also Adjunct Senior Lecturer in Pharmaceutical Medicine, School of Medical Sciences at the University of New South Wales. Here, Shaw issues a rebuttal of critiques that the pharma and biotech industry is ‘too profitable’, arguing instead that its profits are in line with other innovative, high-technology sectors.

 

There’s no doubt pharmaceutical and biotech companies have some major challenges they need to confront going forward, but that’s not to say that the industry should not be profitable.

The renowned economist, Joseph Schumpeter, once said that “Profit is the payment you get when you take advantage of change”.

This might be something worth reflecting on in the midst of the current furore over the price of medicines.

We sometimes hear critics of the biotech and pharmaceutical industries claim that the industry is too profitable and that it makes too much money.

This is sometimes used as a justification for drastic measures to blame the industry for funding problems in health systems.

 

How Profitable is the Pharma and Biotech Sector?

We saw an attempt to examine this recently in a report released last year by the OECD Pharmaceutical Innovation and Access to Medicines.

In many places, the report has a good explanation of the contemporary state of the pharmaceutical industry and has a lot of good data on health and the pharmaceutical industry.

But buried in the report is a chart and some research that the OECD tries to use to argue that the pharmaceutical industry has “high and stable returns” and, by implication, can afford to have its prices reduced.

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The OECD analysis has several flaws but tries to make a risk-adjusted assessment of the profitability of industries to suggest that the pharmaceutical industry is making too much profit.

However, I’m not so certain this analysis tells the full story when it comes to profits.

The chart is interesting for several reasons

  • Without knowing the 87 companies the OECD has selected as R&D-based pharmaceutical companies, these companies have seen the excess of their profitability over their cost of capital halve since 2002 from six per cent to less than three per cent – a fall that would visually appear much more significant if tobacco had not been included in the chart
  • If the chart is to be believed, the rest of the pharmaceutical industry is in dire trouble as it has seen its profitability deteriorate since 2010, approaching a profitability level of six per cent less than their cost of capital. This could have undesirable knock-on effects in the health system contributing to things like drug shortages and poor-quality generics
  • The tobacco industry is one of the most profitable industries, with profit levels steadily increasing to at least 12 per cent above what their cost of capital is, and
  • Nowhere in the chart does the analysis include several other high-technology manufacturing and service industries such as software and computer services, banking, and fixed-line telecommunications. This is curious given these other industries are among some of the fastest growing in the world.

 

A Broader Perspective

More recent data from the European Commission’s 2018 EU Industrial R&D Investment Scoreboard published just before Christmas might help fill in some of these gaps.

The annual EU survey collates data from 2,500 global firms around the world that conduct R&D and has lots of fascinating comparative data at the industry and company level.

While these figures are not adjusted for the cost of capital as the OECD attempted to do, they do give a general picture of the profitability of the pharmaceutical industry vis-à-vis other industrial sectors, including several industries that the OECD unfortunately missed in its analysis.

It turns out that, according to the EU’s 2018 report, the most profitable major industrial sectors in order are:

  1. Banking, where profits represent 30.8% of total net sales
  2. Software and computer services at 15.4%,
  3. Pharmaceuticals and biotechnology at 14.9%,
  4. Technology hardware and equipment at 14.0%, and
  5. Fixed line telecommunications at 13.7%.

Interestingly of all these industrial sectors Pharmaceuticals and biotechnology invests the most in R&D and invests more of its revenue in R&D (15.0%) than any other sector. In fact, its rate of 15% is almost double the next most R&D-intensive industry which is Technology hardware and equipment (8.7%).

Worryingly, during the 2017/18 period, the Pharmaceutical and biotechnology sector saw its profits fall by 10.6% when just about every other sector of the 15 industrial sectors analysed except for General industrials saw their profit levels rise – in many cases substantially.

It is also worth noting that the Pharmaceutical and biotechnology sector is the only sector listed here that invests more in R&D than it earns in profits.

Every other industrial sector earns more profit than it invests in R&D.

 

Tobacco, Mining and Banking More Profitable

And these are just the 15 ‘top’ sectors selected in the report based on their investment in R&D.

When you analyse the data for all the sectors captured by the analysts at the European Commission, acknowledging that the sample sizes for some sectors in the survey are small, it turns out that the OECD was right about one thing.

Tobacco is the most profitable industry sector in the world with a 34.1% profitability ratio, meaning that for every €100 of worldwide sales of tobacco the tobacco companies receive €34.1 of that in profit.

 

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At least on these figures, the Pharmaceutical and biotechnology sector ranks 7th in profitability at 14.5%, putting it behind Tobacco (34.1%), Mining (28.1%), Banks (26.9%), Financial services (25.1%), Beverages (which includes beer brewing and soft drink manufacturers) (19.8%) and Software and computer services (15.4%).

Most of these industries were not included in the OECD analysis.

Notably, the pharmaceutical industry falls behind the software industry in terms of profitability and is just ahead of the personal goods and tech hardware industries.

Profitability figures can vary wildly from year to year, but the conclusion here seems to be that while the pharmaceutical and biotech sector is one of the more profitable sectors in the global economy, it is by no means the most profitable.

These figures suggest that investors – be they pension funds, retirees with their savings or young kids starting an investment account – could earn greater returns from investing in tobacco companies, mining companies, banks, financial services, beer brewing and tech companies than they would investing in companies that develop new medicines and vaccines.

Arguably, public health advocates should be concerned about this.

At a time when the world is trying to ensure the continued development of new medicines, vaccines and medical technologies to help fight disease, the fact that people can earn more money investing in things like tobacco, alcohol and banking services is a worry.

 

So What?

The point is that while some criticise the pharmaceutical and biotechnology industry for being ‘too profitable’, in fact its profit levels aren’t that much out-of-kilter with the profit levels of other high-tech industry sectors.

As much as it may gall some people, profit is what has driven a lot of technological and human progress over the millennia.

In fact, in some cases it trails other industry sectors’ profitability, despite the development of new medicines being one of the higher risk entrepreneurial activities that businesses can undertake.

The pharmaceutical and biotech sector is not the most profitable industry but is certainly up there with other innovative, high technology sectors.

And perhaps it should be, given the types of products and services the pharmaceutical industry delivers.

As is often the case in business and economics, the picture isn’t always as simple as a slogan on a protester’s banner.

There’s no doubt pharmaceutical and biotech companies have some major challenges they need to confront going forward.

But that’s not to say that the industry should not be profitable.

As much as it may gall some people, profit is what has driven a lot of technological and human progress over the millennia.

Rather than criticise the industry for making money, perhaps those who want to see industrial change may want to consider how to make the business environment for improving human health more, not less, attractive for companies.

That would demonstrate some real innovative thinking.

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