Biopharmaceuticals: Nothing Compares to You
Are biotech and pharma companies doing well, or falling apart at the seams? People will have differences of opinion on this, but one thing is clear: it’s all relative.
At a speech to a trade group in Philadelphia last month, James Greenwood, president of the biotechnology trade group BIO, asked the government to stop picking on the pharma industry. “The drug industry has laid off more workers than the auto industry, but they get bailed out while we’ve continued to get picked on,” he declared. Unfortunately, Greenwood’s comparison of the auto and BioPharma industries was well meaning but seriously misguided. I looked up the profitability of the Big Three auto companies and compared it to three of the largest, US-based pharma companies over a five-year period.
Here’s the data, on yearly profits or losses, in billions of dollars. Losses are expressed in parentheses, and the * indicates results following bankruptcy.
Which industry do you think has had the rougher time in the past five years?
Big pharma and the auto industry are both dominated by multi-national corporations that employ huge numbers of people. Both industries have a high cost-of-entry barrier that limits competition. And it’s also true that both the auto industry and big pharma each laid off hundreds of thousands of workers in the past few years. In the auto industry, however, the largest layoffs were focused on the people who actually built the cars. In contrast, big pharma didn’t lay off the people who make the drugs; they primarily laid off the folks who created, marketed, and sold their products. I point this out to illustrate that gross comparisons between the auto industry and pharma, are, well, rather meaningless. The two industries aren’t really comparable in a large number of ways. People die if they can’t get certain medicines, but I never heard of someone passing away because they couldn’t get a new Chevy.
Despite their recent setbacks, Big Pharma companies are still making money at a rate that other industries can only dream of. Pharmaceuticals have traditionally been one of the most profitable areas of commerce. In 2002, for example, Public Citizen calculated that the combined profits of the top 10 drug companies exceeded the combined profits of the other 490 companies in the Fortune 500. Big Pharma is currently sitting on so much cash, BIO estimates that the top 10 pharmas could pay a 50 percent premium and still acquire 93 percent of all publicly traded biotech stocks in the U.S. Johnson & Johnson alone has enough money to buy half of all biotech firms. A final example: Pfizer has sold a staggering $131 billion worth of a single medicine, Lipitor, since the drug reached the market in 1997. One method for achieving these large profits and maximizing short-term “shareholder value” has been the massive, industry-wide layoffs instituted over the past few years, adding substantially to our nation’s unemployment woes. I dislike the term “shareholder value.” It’s vague, ill defined, and references an amorphous group of people that have things done in their name that I’m not sure they ever asked for.
While I’m on the subject of “shareholder value”, Amgen’s latest round of layoffs was explained by one industry analyst as being a result of the company spending too high a percentage (around 19 percent) of its income on R&D. It was, apparently, “a little on the high end of the industry,” and unnamed “shareholders” wanted that percentage to be reduced. I suspect that most Amgen shareholders would have preferred to cut the enormous pay package of CEO Kevin Sharer, the current poster boy for overpaid chief executives. Back in 2008, Forbes Magazine ranked Sharer 169th out of 175 CEO in terms of performance vs. pay. More recently, the Washington Post selected Sharer to illustrate a ludicrous practice known as “peer benchmarking” that increased his compensation 37 percent this year, despite continued underperformance of the company. Don’t you think Amgen’s board could find someone who was qualified to run it, and would do so willingly, for a fourth (or even a tenth?) of the $21 million Sharer is making?
Being ignorant of conventional corporate budgeting practices, I didn’t realize that companies were “mandated” to spend a particular percentage on R&D. If increased R&D expenditures led to more drugs in the pipeline, and eventually to more profits, then wouldn’t this justify an increase in R&D spending? Similarly, if a company cut their R&D spending to 10 percent of revenues, and this resulted in a sub-standard number of drug approvals and reduced profits, wouldn’t shareholders howl that too little was spent? Cutting back on research and development, at some level, will erode the ability of a company to find and create new drugs. Assuming you have a competent research program, the more you cut back on R&D, the lower the likelihood of coming up with new medicines. And if you don’t have a competent research and development program, well, then you’re in the wrong business to begin with. At some point your company won’t be able to develop any new drugs on their own, and they will be forced to acquire drugs for their pipelines from other businesses.
There is nothing inherently wrong with this alternate approach of getting new drugs by buying, rather than creating them from scratch. If everyone took this approach, however, there would be no companies to acquire since no one would be doing the basic research work. It’s not clear to me where the cost of acquiring other companies appears on the company balance sheet, but I doubt it all gets charged to R&D. Budget wise, isn’t this really robbing Peter to pay Paul? Do the majority of acquisitions in this industry indicate that the acquiring company did a relatively poor job of managing and creating value from their internal R&D dollars?
Biopharma, as I stated at the beginning, is a unique business. It can’t be readily compared with any others that I can think of. It has a very high cost of entry, its products require a strict and lengthy regulatory approval process, and its intellectual property can’t be replaced by trade secrets. It spends a significantly higher percentage of revenue on R&D than many other industries (tech star Apple spends less than 3 percent of revenue on R&D) because what it is trying to accomplish is amazingly difficult. Most of the products it produces are designed to last only days or hours. Some of them will be used only once in a lifetime, while others will be taken for a lifetime. Let’s not concern ourselves with how Biopharma compares to autos, to finance, or to agriculture. Instead, we should focus our energies on what’s really important: making sure the industry is fully prepared to research and develop the medicines of tomorrow. As Jack Kerouac said, “Great things are not accomplished by those who yield to trends and fads and popular opinion.”