Prescription Drug Prices and Profits

For several years the pharmaceutical industry has been under attack by those who are using the industry for political purposes. Some attack the pharmaceutical industry with the goal of establishing a government-run healthcare system, while others are simply gaining votes and campaign contributions from those with a grudge against the industry.

But the demonizing of an industry doesn't come without costs. And the demonizing of the pharmaceutical industry could result in an enormous cost to society in terms of pain not relieved, diseases not cured, and lives not saved. This paper seeks to answer several common criticisms and expose the absurdity of the accusations.

Criticism #1. The pharmaceutical industry is the most profitable in the country.

The implications of this criticism are that drug companies could lower their prices significantly and still be profitable, and that there is some publicly acceptable level of corporate profits that should not be exceeded.

But as any economist or businessperson knows: high prices don't ensure profitability, and low prices don't necessarily mean low profits.

In Fortune magazine's annual ranking of the top 500 companies, the fourteen companies that make up the the "pharmaceuticals" category had a median profit (as a percent of revenue) of 18% in 2001 more than any other industry median. The most profitable drug company on the list was Amgen at 28%. But Pharmacia and Abbott Labs both reached only 7% profit, and Genzyme recorded a 9% loss. On the other hand:

• Coca-Cola had a 20% profit;
• Bank of New York made 19% and Mellon Financial 33% (more than any drug company);
• Microsoft hit 29% and Oracle 24%;
• Gannett (publisher of USA Today) recorded 13% while Knight-Ridder reached 15%;
• AT&T made 13% and SBC Communications earned 16%.
• The Washington Post can boast of a 10% profit, as much or more than four of the drug companies on the list.

Yes, most "Innovator" drug companies make above-average profits. But that is exactly what you would expect and want. Any economist knows that the riskier the business, the higher the profits must be to induce entrepreneurs to take that risk. A person or company would not assume an above-average risk unless there were the potential for above-average profits. Creating new drugs is one of the riskiest of all businesses, with only about one out of 5,000 new chemical compounds making it to market and only three out of ten new approved drugs actually meeting or exceeding their research and development costs.

Profits must be high in order to attract risk-taking companies. Yet Coca-Cola made more money in most years of the 1990s than the median pharmaceutical company, and no one accuses that company of price gouging, or of taking above-average risks to accomplish some great social good.

Criticism #2. Prescription drug prices are too high.

Too high in comparison to what? The average price of a retail prescription is about $50. A family of four going to the movies can easily spend $25 for admission and another $25 on refreshments. Surely a prescription drug that relieves pain or cures a medical condition is worth as much as a night at the movies.

Or consider that a "clean, comfortable" room at moderately priced motels can also cost around $50 for only one night. Better hotels can cost $150 to $200 a night or more four times the average cost of a prescription drug.

People regularly and voluntarily spend as much or more money than they do for a prescription on things they want even though they may get more benefit from the drug. But they don't complain to their elected representatives about the cost of movies like they do the cost of drugs.

Criticism #3. Drug prices are high because pharmaceutical companies pay their CEOs outrageously high salaries.

While many of the drug companies pay their CEOs well, those salaries are not out of line with other companies their size. Indeed, they may be on the low side.

USA Today recently ranked total "compensation packages for 103 CEOs at 100 top companies," including the "potential value of stock option grants," and guess what? Lots of CEOs did much better than drug company executives.

Oracle was ranked first because the CEO's salary, plus add-ons and potential stock options, brought his total compensation to $706 million in 2001. Cisco Systems and SBC communications ranked second and third, respectively. IBM ranked fifth. Even the CEO of Coca-Cola came in ninth with $100 million 30% more than the highest-paid drug company CEO.

The list below suggests that pharmaceutical executives don't make it into the ten top-paid CEOs. (compensation packages, including stock options, 2001, are from USA Today, March 25, 2002):

And yet:

• Pfizer's CEO came in down at 15 on the USA Today chart, even though Pfizer is the fifth largest company in the world, according to the Wall Street Journal.
• Abbott Laboratories' CEO ranked 23, Schering-Plough's was 51, Eli Lilly 55, and Johnson & Johnson 88, even though Johnson & Johnson is the fifteenth largest company in the world.

But why stop with corporate CEOs? According to Parade magazine:

• TV newswoman Diane Sawyer made $10 million in 2001.
• Actress/singer Jennifer Lopez took in $14.4 million
• Singer Britney Spears raked in $38.5 million.
• Baseball player Mike Piazza got $15 million, basketball great Shaquille O'Neal received $29 million, and ex-con Mike Tyson brought in an astounding $48 million.

And none of these "stars" employ 100,000 people all over the world. Where is the outrage over these exorbitant incomes?

Here is the real irony. There is a general awareness in our society that those who add a lot of value to it, such as teachers, often don't receive nearly the compensation they should. Yet the pharmaceutical industry adds tremendous value in its quest to relieve pain and suffering and cure disease and pays its employees better than average but critics still complain [Editor's note: If the critics are worried about health, you'd think they'd be more outraged by the Philip Morris CEO's high pay].

Criticism #4. Drug companies are "profiting from pain."

Actually, drug companies profit from the relief of pain and suffering.

People must have food on a daily basis, yet no one says that farmers and grocers are profiting from starvation.

When people travel, they usually need a place to stay at night. Fortunately, there is a system of hotels and motels across the country ready to meet the travelers' needs. But no one seriously claims that hotels are profiting from homelessness. On the contrary, travelers who need a place to stay are thankful the hotel industry provides lots of options on price, quality, service and convenience.

Praiseworthy

Like food and hotels, the drug industry makes a product that many people want and need. Unlike those industries, the innovator drug companies take enormous financial risks. That most drug companies manage to earn a profit, especially in troubled economic times, should elicit praise, not criticism.

Dr. Merrill Matthews Jr. is a Visiting Scholar at the Institute for Policy Innovation, and this article originally appeared in the January 9 issue of their newsletter Ideas.

Responses: April 15, 2003 Dr. Merrill Matthews makes some great points in comparing drug companies to other business enterprises. The difference between drug companies and most other companies is that drugs are something you must buy due to disease or illness, and other companies offer something that you desire. So psychologically there is a huge difference in feeling towards the companies. And there is no way you can change this basic human behavior. A.E. Martin September 17, 2003 Some of the complaints about drug prices may be unfounded, but unfortunately drug industry "marketing behavior" is highly contentious (one may have noted recent lawsuits regarding "bribery" and "Medicare fraud") and rather costly. It might be interesting to compare "marketing expenses" with the actual expenses for research, development, and clinical testing. Nevertheless, drug research will always be expensive and drugs will therefore be expensive (though usually not as expensive as hospitalization), even if marketing costs are limited. Ruben E. Smit Senior Analyst Socially Responsible Investments