More MS news articles for July 2002
Drug Company Profitability and Investments in Research: A Fact Sheet
July 2, 2002
By Joe Moser
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.
And the pharmaceutical companies pay more taxes than most other companies.
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
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).
The research-based pharmaceutical industry spends a significant percentage
of its sales revenues on research and development.
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,
There is a direct link between gross profitability and pharmaceutical R&D
spending. As pharmaceutical companies make more money, they spend more
No other industry - from electronics to telecommunications - commits a
higher percentage of sales revenues to new innovation and future advances
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).
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.
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).
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.
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).
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.
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.
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.
98% of doctors said patent rights were very or somewhat important as an
incentive for drug production (Bandow, 5/17/02)9.
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:
1 The 2002 Fortune 500 Industry Rankings. "How the Fortune 1000 Stack
Up In Their Industries." Fortune. April 15, 2002. 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
3"Taxing the Pharmaceutical Industry" PhRMA Backgrounder. July 17,
2000. Available online at www.phrma.org/publications/documents/backgrounders/2000-07-17.208.phtml
4"The Myth of 'Rising Drug Prices' Exposed." PhRMA Backgrounder. March
6, 2002. Available online at www.phrma.org/publications/documents/backgrounders/2002-03-06.333.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.
© Galen Institute 2002