How Much Can Pharma Lose? - West Health

[Pages:15]How Much Can Pharma Lose?

A Comparison of Returns Between Pharmaceutical and Other Industries

Sean Dickson, JD, MPH Director, Health Policy West Health Policy Center

Jeromie Ballreich, PhD, MHS Director, Masters in Health Economics and Outcomes Research Program Johns Hopkins Bloomberg School of Public Health

The West Health Policy Center is focused on research and education to identify innovations and policy solutions that can slow the trajectory of rising healthcare costs while improving access to--and the quality of--care, particularly for our nation's growing population of seniors. Specific areas of focus include reducing growth in U.S. spending on prescription drugs, promoting value-based care models, increasing price transparency, and limiting consumer exposure to high out-of-pocket costs. Solely funded by philanthropists Gary and Mary West, the Policy Center is based in Washington, D.C., and is part of West Health, a family of nonpartisan, nonprofit organizations dedicated to lowering the cost of healthcare to enable successful aging.

Authors

Table of Contents

Sean Dickson, JD, MPH is director, health policy, at West Health Policy Center. He is a nationally recognized technical expert on the American drug system, including the full market lifecycle of pharmaceuticals. He can be reached at sdickson@ and on Twitter @sean_r_dickson.

Jeromie Ballreich, PhD, MHS, director of the Masters in Health Economics and Outcomes Research program at Johns Hopkins Bloomberg School of Public Health. He is a health economist specializing in pharmaceutical economics and policy, economic evaluations alongside clinical studies, and high-cost/high-needs patient populations with a focus on trauma. He can be reached at jballre2@jhu.edu.

3 Introduction 4 Background 5 A Bifurcated Industry 6 Profitability Across Industries 9 Revenues and Competitiveness 11 Risk Across Industries 13 Discussion 14 References

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Introduction

Whenever policymakers consider approaches to reduce drug spending, the pharmaceutical industry sings a familiar refrain -- any reduction in drug manufacturer revenues will cause investment to wither, depriving manufacturers of the resources needed to research and develop future treatments. The empirical validity of this argument has not, to our knowledge, been analyzed. In this analysis, we consider the historical level of returns on invested capital in the pharmaceutical industry and compare it to other industries; we then consider how much lower pharmaceutical industry revenues could be while maintaining returns at or above other industries. We find that large pharmaceutical manufacturers could endure significant revenue reductions, including the reductions considered in recent legislative proposals,1 while maintaining current research investments and still achieve the highest returns of any market sector.

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Background

When attempting to regulate pharmaceutical spending, policymakers frequently assert that pharmaceutical manufacturer returns are significantly higher than other industries. A 2006 Congressional Budget Office report was among the first to systematically assess the question and provide support to some lawmakers' belief that the pharmaceutical industry could remain profitable with lower revenues.2 More recently, the Government Accountability Office compared profit margins for drug companies and other industries, finding that margins for the largest drug companies significantly outpaced margins among the 500 largest companies in other industries.3 Alarmed by the power of this argument, the industry has repeatedly attempted to justify high revenues with the costs of bringing a drug from theory to market, funding research that estimates high drug development costs4 and citing losses associated with products that seemed promising but ultimately were unsuccessful.5 Historically, these arguments have proved relatively effective, leaving a largely-unregulated drug pricing landscape and resulting in the pharmaceutical industry being considered among the most effective lobbying groups in Washington, DC.6 This argument has reprised itself in current debates on drug spending. During hearings in the House Energy and Commerce Committee7 and the House Education and Labor Committee,8 both witnesses and lawmakers considered sympathetic to the pharmaceutical industry raised concerns about the impact on investment in drug companies and the subsequent impact on innovation. Throughout these debates, however, there has been little evidence of the relative differences in investment returns between the pharmaceutical industry and other industries, nor consideration of the magnitude of a revenue reduction that the pharmaceutical industry could sustain and remain a competitive investment choice.

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A Bifurcated Industry

One of the principle arguments against reducing pharmaceutical industry profits is that lower profits will lead to less investment in early-stage research and discovery, harming the pipeline for future drug innovation. This argument, however, does not differentiate between investment in companies that engage in early-stage development and companies that focus on bringing promising therapies to market. According to the Government Accountability Office, "traditionally large companies are increasingly relying on mergers and acquisitions to obtain access to new research and are conducting less of their own research in-house."9 This approach leverages large pharmaceutical companies' resources to conduct later-stage trials and navigate the approval, distribution, and marketing processes. It is these large, publicly-traded pharmaceutical companies whose revenue would be directly reduced by any new drug spending regulations.

"Traditionally large companies are increasingly relying on mergers and acquisitions to obtain access to new research and are conducting less of their own research in-house."

-- Government Accountability Office

If large pharmaceutical companies are the entities directly affected by drug spending regulations, how would these regulations affect earlystage research companies? One plausible explanation is that large pharmaceutical manufacturers would offer lower prices for the acquisition of candidate drugs, reducing the potential profit that could be realized by early-stage companies and their venture capital investors. However, this may not be the case ? the price paid for candidate drug acquisition has grown significantly over the past decade due to the competitive nature of these acquisitions,10 and it is unknown whether early-stage companies and their investors would accept lower prices to maintain large pharmaceutical companies' current profit margins. If early-stage companies do not reduce their prices from current levels, the cost of drug acquisition becomes closer to a fixed cost, and the question becomes whether a large pharmaceutical company can remain sufficiently profitable with lower revenue and fixed costs to maintain current levels of investment.

For our analysis, we chose a measure ? Net Operating Profit After Tax (NOPAT) ? that includes the cost of drug acquisitions when considering each company's and industry's returns on investment. That means that the investment returns after lower revenues that we model for pharmaceutical companies include current expenses for drug acquisition. Our findings suggest that early-stage research companies and their investors could hold out for prices consistent with current rates and large pharmaceutical companies could still achieve market-leading returns even with lower revenues. Put simply, our analysis indicates that early-stage research companies and their investors could still maintain their current profit margins without reducing large pharmaceutical companies' relative advantage in returns over other industries.

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Profitability Across Industries

For this analysis, we focus on the impact of drug spending regulations on large pharmaceutical companies, which we define as manufacturers that predominantly market brand drugs, are members of the PhRMA trade association, are publicly-traded, do not solely focus on orphan drugs, and whose public financial filings are sufficiently-included in the CompuStat database to allow us to calculate returns. CompuStat is a financial data aggregator that provides company financial data in a standardized, machine-readable format. The 23 companies included in our analysis are listed in Table 1. Together, drugs sold by these manufacturers accounted for 58% of gross Medicare drug spending in 2017 ($104.9B of $181.1B) and 72% of brand drug spending ($104.1B of $144.9B, per the Medicare Parts B and D Dashboards).11

To compare returns among large pharmaceutical manufacturers with other industries, we use Return on Invested Capital (ROIC). ROIC compares a company's net operating profit after tax to its total invested capital. Specifically, we calculated ROIC as:

We used CompuStat to access financial data from 2009 to 2019 for 2,193 companies. We cal-

culated ROIC using a 12-month trailing average for returns divided by quarterly invested capital,

in line with industry approaches. Because of this trailing average and because some industries

had data gaps for 2009, we only report ROICs beginning in 2011. To calculate NOPAT, we

subtracted quarterly taxes from quarterly operating income after depreciation. We used the

invested capital summary variable provided by CompuStat, which is the sum of the Book Value

of Equity, Preferred Stock, Non-Controlling

Interest in Consolidated Subsidiaries, Long-Term Debt, Capital Notes, and Mortgage Indebtedness minus Treasury Stock. We calculated the annual

The 23 large pharmaceutical manufacturers in this analysis had profits of $1.2T from 2011-2019.

ROIC for each pharmaceutical company as well

as the total ROIC for the period (Table 1); we also

calculated annual ROIC by industry based on CompuStat's industry categories as well as ROIC

for the period for each industry (Table 2). We also report total NOPAT for each company and

industry for comparison. Analyses were performed in Stata and Excel.

Across the study period, large pharmaceutical manufacturers have the highest average ROIC of any industry group. In fact, in nearly every year of the period, pharmaceutical manufacturers' ROIC leads all other industry groups. Overall, large pharmaceutical manufacturers see a period ROIC of 17.3%, compared to an unweighted average 11.5% across all other industries (excluding large pharmaceutical manufacturers). This high ROIC among large pharmaceutical manufacturers suggests that a reduction in profit may not lead institutional investors to shift funds to other industries.

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Table 1

Return on Invested Capital and Total Profits among Large Pharmaceutical Manufacturers, 2011-2019

Company

2011

2012

Return on Invested Capital (ROIC) 2013 2014 2015 2016 2017 2018

Period Profits 2019 Period (in millions)

Abbott Laboratories 21.3% 12.8% 8.9% 7.6% 9.1% 10.5% 5.0% 5.5% 7.7% 9.4% $29,139.3

Abbvie Inc.

47.2% 42.8% 31.1% 30.9% 27.3% 19.8% 21.2% 36.2% 53.7% 36.2% $65,685.8

Allergan PLC

9.8% 10.6% 6.2% N/A 1.4% 1.9% 3.6% 5.4% 2.3% 3.2% $16,366.7

Amgen Inc.

13.0% 12.8% 12.4% 11.2% 12.6% 13.5% 11.6% 10.7% 22.8% 13.7% $55,642.0

Astrazeneca PLC

30.1% 28.8% 19.9% 14.7% 14.8% 15.1% 15.5% 12.9% 13.7% 19.4% $47,063.0

Bayer AG

15.6% 17.7% 16.6% 14.4% 14.4% 14.6% 12.1% 7.1% 8.2% 13.3% $55,312.9

Biogen Inc.

22.7% 23.5% 21.9% 23.0% 24.9% 23.7% 22.6% 21.0% 26.9% 27.0% $27,896.6

Bristol-Myers Squibb Co.

22.3% 23.4% 16.0% 12.8% 10.6% 11.3% 11.6%

6.0% 17.8% 15.8%

$27,662.0

Celgene Corp.

17.3% 21.1% 20.5% 17.7% 15.5% 16.1% 21.7% 18.1% 22.1% 22.0% $27,150.2

Eisai Co Ltd.

8.7% 7.5% 5.6% 6.1% 5.4% 6.3% 5.0% 9.2% 8.8% 7.0% $4,079.6

Gilead Sciences Inc. 27.4% 20.2% 20.1% 36.3% 48.8% 41.9% 22.5% 8.9% 14.6% 30.2% $71,906.2

Glaxosmithkline PLC 17.2% 25.2% 21.6% 23.6% 12.4% 26.7% 33.1% 26.3% 26.9% 25.5% $65,467.3

Johnson & Johnson

18.8% 18.4% 19.2% 20.2% 18.2% 17.4% 14.1% 8.5% 20.9% 18.3% $125,039.0

Lilly (Eli) & Co.

28.3% 20.4% 20.2% 14.4% 14.3% 13.6% 14.4% 15.2% 32.4% 19.3% $33,089.3

Mallinckrodt PLC

N/A N/A 5.8% 5.7% 6.2% 8.0% 10.1% 15.0% 10.9% 10.9% $5,915.7

Merck & Co.

12.8% 12.2% 11.0% 10.9% 6.7% 12.5% 12.4% 7.3% 19.2% 11.9% $63,950.0

Novartis AG

13.3% 12.5% 12.0% 11.6% 9.5% 8.1% 6.7% 7.3% 10.3% 10.2% $72,788.0

Novo Nordisk A/S

42.3% 56.4% 63.8% 68.4% 84.9% 89.9% 80.5% 76.9% 74.1% 95.0% $41,481.0

Pfizer Inc.

13.8% 12.5% 8.4% 9.2% 11.4% 14.5% 15.6% 21.8% 16.6% 14.2% $119,700.0

Regeneron Pharmaceuticals

-22.6% 13.4% 37.6% 14.5% 14.6% 17.6% 18.3% 21.2% 22.1% 22.7% $7,364.6

Roche Holding AG

71.8% 73.9% 78.7% 70.6% 61.8% 59.7% 53.1% 61.3% 70.4% 85.9% $117,732.9

Sanofi

19.8% 20.5% 16.8% 17.1% 18.3% 18.1% 15.8% 13.8% 16.1% 18.4% $62,900.0

Shire PLC

26.7% 22.5% 28.3% 27.4% 23.4% 8.2% 8.8% 12.2% ^ 13.4% $20,458.8

Overall

18.4% 19.6% 17.7% 16.2% 14.7% 15.7% 14.8% 13.1% 17.8% 17.3% $1,163,791.0

N/A - Insufficient data reported to calculate

Johnson & Johnson's 2018 income before tax was 65% attributable to pharmaceuticals, 23% attributable to medical devices, and 12% attributable to consumer products. ROIC was calculated using total revenues, as invested capital could not be directly allocated to the pharmaceutical business.

^Shire was acquired by Takeda in January of 2019; Shire's historical financial data were used for ROIC

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Table 2

Return on Invested Capital by Industry, 2011-2019

Industry*

Return on Invested Capital (ROIC)

Period Profits

2011 2012 2013 2014 2015 2016 2017 2018 2019 Period (in millions)

Large Pharmaceutical Manufacturers

18.4% 19.6% 17.7% 16.2% 14.7% 15.7% 14.8% 13.1% 17.8% 17.3% $1,163,791.0

Accommodation and Food Services

13.3% 12.4% 13.5% 14.8% 13.4% 14.1% 13.7% 16.7% 12.8% 15.3%

$207,850.6

Administrative and Support and Waste Management and Remediation Services

11.7% 12.0% 11.8% 11.9% 13.2% 11.3% 12.4% 13.7% 12.8% 13.3%

$95,818.3

Agriculture, Forestry, Fishing, and Hunting

11.2% 12.6% 14.1% 13.6% 16.5% 24.1% 16.4% 56.0% 2.7% 13.5% $32,946.7

Arts, Entertainment, and Recreation

6.5% 7.2% 8.2% 10.2% 7.3% 8.7% 8.8% 14.9% 6.8% 9.5% $15,703.6

Construction

4.7% 5.1% 10.7% 11.1% 7.4% 6.4% 6.7% 6.6% 8.4% 8.4% $62,204.7

Educational Services

31.2% 23.7% 15.5% 11.0% 6.5% 12.4% 8.2% 9.2% 5.3% 12.6%

$7,682.7

Finance and Insurance

6.6% 7.2% 7.6% 8.0% 7.6% 7.0% 7.0% 7.2% 8.4% 8.4% $3,244,796.0

Health Care and Social Assistance

14.9% 13.2% 12.4% 10.3% 11.0% 9.9% 9.4% 11.0% 11.8% 12.0% $133,522.8

Information

12.6% 12.7% 12.2% 12.9% 10.5% 11.2% 10.7% 13.4% 11.2% 12.9% $1,717,511.0

Manufacturing

14.1% 14.9% 14.9% 12.5% 13.0% 11.4% 10.5% 10.6% 12.4% 13.5% $3,879,422.0

Mining, Quarrying, and Oil and Gas Extraction

8.8% 7.9% 5.5% 6.6% 1.8% -13.9% -1.5% 5.5% 6.1% 3.0% $182,968.8

Other

5.6% 6.3% 6.0% 5.8% 3.8% 6.7% 6.8% 8.7% 7.0% 6.5% $352,984.7

Other Services (except Public Administration)

17.8% 14.1% 9.4% 12.2% 11.0% 12.7% 13.0% 16.8% 16.3% 14.6% $11,869.1

Pharmaceutical and Medicine Manufacturing^

14.7% 15.9% 12.4% 11.2% 8.6% 8.4% 10.5% 8.5% 11.5% 11.6% $101,077.4

Professional, Scientific, and Technical Services

20.2%

15.4%

15.7%

14.8%

14.0%

13.9%

12.2%

13.5%

12.2% 15.3%

$159,201.5

Real Estate and Rental and Leasing

4.6% 4.7% 4.9% 4.8% 5.1% 5.3% 5.6% 5.5% 5.2% 5.5%

$316,180.4

Retail Trade

13.4% 13.6% 13.5% 12.9% 13.9% 14.1% 14.3% 14.9% 12.4% 15.0% $700,901.1

Transportation and Warehousing

9.7% 10.9% 9.7% 12.0% 10.7% 13.5% 10.3% 15.2% 9.9% 12.4% $457,010.3

Utilities

7.8% 7.2% 7.0% 7.2% 6.8% 6.4% 6.9% 7.2% 6.6% 7.3% $550,401.7

Wholesale Trade

12.3% 13.1% 13.1% 11.8% 12.1% 12.1% 11.2% 12.6% 12.9% 13.5% $159,252.5

*Large Pharmaceutical Manufacturers listed in Table 1; other industry categories as defined by CompuStat

^Excludes pharmaceutical manufacturers included in the Large Pharmaceutical Manufacturer category

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