Pharmaceutical Marketing And Research Spending

Pharmaceutical Marketing and Research Spending: The Evidence Does Not Support PhRMA’s Claims Prescription drug pricing policy debates often revolve around the impact of reform proposals on drug makers’ ability to conduct research. Brand name drug companies usually describe research and development as their top priority, and a bigger focus of their spending than marketing and advertising. We’d like to offer some evidence about the industry’s claims and what drug makers are really spending their money on. We’ll touch on two main areas: • the drug makers’ commitment of resources to marketing and to R&D, and • research spending of U.S. firms compared with those in other nations. And we’ll offer a final note about profits. Research and marketing First, the pharmaceutical industry association, PhRMA, asserts that its members spent 20 percent of their sales revenues on R&D in 1997 and 1998, and 18.5 percent this year (up from 16 percent in 1990). 1 But it’s hard to see how this can be. We see real reasons to question their figures. Last year, a colleague looked at annual reports of six of the biggest drug makers, and found that just 11 percent of revenues went for R&D in those firms. 2 (See Exhibit 1, “How Six Drug Makers Spent Their Money, 1999,” included at end of paper.) That’s far below the 18.5-20.0 percent levels that the industry says it devotes to R&D. We suggest that the drug makers need to explain the disparity—why does the evidence from their own annual reports show a much lower share of revenue for research than the industry claims? Further, according to these firms’ annual reports, • 16 percent of revenues was taken as profit, and • 31 percent went for marketing and administration. That’s nearly three times as much as their R&D spending. This is actually a long-standing pattern. In the 1950s, Senator Estes Kefauver’s investigation found that drug companies spent 24 percent of revenue on promotion—four times their spending on research.3 The share spent on R&D in those six firms in 1999 was matched in a recent Kaiser Foundation analysis which looked at the 10 largest firms in 1998, again finding 11 percent of sales going to R&D—and finding similar percentages over the whole decade.4 Comparable figures were reported for 2000 by Public Citizen5 and Families USA.6 2 Analyses of drug makers’ financial data often have noted that the share of revenues being spent on R&D is just one-half to one-third the share spent on marketing, advertising and administration combined.7 Another way to measure the industry’s priorities is by employment. And that permits not only looking at drug makers’ commitment to R&D, but also separating out administration from marketing. We find that U.S.-based brand name drug companies, by their own data,8 have fewer employees in R&D than in marketing alone. PhRMA reported that in 1995 there were about 49,000 workers in research and development, and 55,000 in marketing. Through much of the 1990s, R&D employment at PhRMA member firms was essentially stable. But between 1995 and 2000, the number of people they employed in marketing rose by more than 30,000, or an astounding 59 percent—from 55,000 to over 87,000. (See Exhibit 2, “R&D and Marketing Employment, 1995 and 2000.”) The vast majority of these 87,000 marketing employees are apparently sales people, the detailers promoting drugs to physicians, HMOs, and other providers. The next exhibit, again from the industry association’s own data, shows the number of people in all the major job categories in pharmaceutical firms over a slightly longer period. Marketing is the largest category and the only one that has been rising substantially. (See Exhibit 3, “Marketing, Research, and Other Employment, 19932000.”) Strikingly, given the industry’s claims about their ever-growing research efforts, their R&D employment was actually slightly higher in the mid-1990s than it was in 1999 and 2000. Marketing alone is where the brand name drug makers have been expanding employment. And as Exhibit 3 made clear, marketing also is by far the largest job category. This is one reason to suspect that marketing expenses make up the majority of that combined marketing and administration spending category that we saw earlier, and that the industry typically includes in its financial reports. The industry might reply that they have begun contracting out substantial amounts of their R&D work, and that only direct employees are included in these numbers. But a number of the brand name drug makers also use outside contracted sales forces to supplement their own detailers. These direct employment numbers also don’t count the people at the advertising agencies that the drug makers use. Direct employment may not be the whole picture either for R&D or for marketing, but it is certainly a reasonable measure to examine—and the one that the drug makers themselves report. 3 We suggest that U.S. drug makers could readily boost their research funding by about $17 billion this year alone, by switching the share of revenue devoted to marketing with the share devoted to research.9 Do U.S. drug makers do extra R&D? The brand name pharmaceutical industry in the U.S. constantly touts what it calls the international leadership of this country’s drug companies in pharmaceutical research and development. What does the evidence show? For several reasons, the U.S. might indeed be expected to contribute a large share of worldwide drug research: • • • • We have great economic resources. Our large population means we can send many people to college and graduate school to study chemistry and biology, and train and provide many scientists for research labs. Overall health care spending here is higher than in any other nation. By some estimates, Americans now make up over 40 percent of the worldwide pharmaceutical market, in terms of dollars of sales.10 (See Exhibit 4, “The World’s Pharmaceutical Market, 1999.”) But do U.S. drug makers in fact spend especially heavily on research? Consider this evidence from the industry’s own data on drug company research in eight leading nations. PhRMA cites data from the Centre for Medicines Research, an industry-financed organization in Europe.11 (See Exhibit 5, “ Prescription Drug R&D Financed by Wealthy Nations’ Drug Makers: National Shares of 8-Nation Total Spending, 1997.”) PhRMA highlights US-based drug makers as the source of more investment in R&D than firms in any of these other seven wealthy developed nations— some of which are small nations, of course. (Please note that the attribution of firms’ research to particular nations may be fairly artificial at this point, given the drug makers’ international operations. They may have labs in several countries working on a product. They may patent it first where they think it will be easiest or gain a large market share fastest. And they can attribute the research to whichever nation they choose.) Among those eight nations, the U.S. is reportedly the source of 39 percent of the drug company-financed R&D, Exhibit 5 shows. But does this equal extra research, beyond what would be expected from the U.S.-based drug makers? The next exhibit compares U.S. pharmaceutical firms’ share of research in those eight nations with the U.S. share of several types of resources that would help support research. (See Exhibit 6, “Health Spending, GDP, Population, and Industry-Financed Drug Research: U.S. Share of Total for Eight Leading Nations, 1997.”) 4 • We find that US drug makers’ share of the company-financed R&D in those eight nations doesn’t, for example, come close to equaling the U.S. share of the same nations’ combined health care spending. The U.S. accounts for over 59 percent of all health spending in those eight nations taken together, but only 39 percent of the industry-financed drug research. • And U.S. companies’ 39 percent share of research spending doesn’t come close to this country’s 47 percent share of the eight nations’ combined Gross Domestic Product. • Indeed, American firms’ share of company-financed R&D seems only proportionate to this nation’s 40 percent share of those eight countries’ population. Thus, by each of several standards, drug companies here do not appear to do the extra research—the disproportionately large amount of research—that the industry claims. High U.S. prices don’t uniquely support U.S. drug makers’ research. Drug makers from throughout the industrial world charge high prices in the U.S.—so any alleged greater research productivity of U.S. drug makers cannot be attributed to this nation’s high prices. A note on profits Drug makers say they have to charge high prices to earn high profits to finance research, or else we’ll all die. In fact, the industry’s widely-reported high profits don’t pay for research. They are what drug makers retain after paying for research and all their other expenses. It’s useful to recognize that the profits on prescription drugs themselves are higher than is suggested by the published and publicized figures from their annual reports and Fortune 500 data. Those figures are for each company as a whole. But many drug makers have some other lines of business with ow profit margins, which drag down the firm-wide average. For example, Merck reported a before-tax profit equal to 26.3 percent of revenue in 1999. But this includes revenues and profits on Merck’s large MerckMedco pharmaceutical benefit manager—a relatively low-margin operation. How much did Merck make on its prescription drug business alone? We found that in 1999 Merck garnered a 37.4 percent before-tax return on revenue on its prescription drug business. Thus, profits before taxes consumed more than 5 one-third of every dollar that patients and insurors struggled to pay Merck for prescription drugs. And that 37.4 percent profit on prescription drugs alone is more than two-fifths greater than the consolidated, firm-wide profit figure that Merck reports.12 (Exhibit 7, “Merck Firm-Wide and Pharmaceutical Segment Return.”) Whether the subject is marketing, R&D, or profits, there’s clearly good reason to treat cautiously all the figures that PhRMA publicizes. It’s vital to dispel the smoke behind which drug makers hide their enormous marketing operations and enormous profits, to the detriment of the research and affordable medications that we all need. 6 EXHIBIT 1 HOW SIX DRUG MAKERS SPENT THEIR MONEY, 1999 Profit 16% Production 32% Taxes 6% Other 4% R+D 11% Marketing + administration 31% 7 EXHIBIT 2 Drug R&D and Marketing Employment U.S. Brand-Name Drug Manufacturers, 1995 and 2000 49,409 Medical R&D 48,527 55,348 Marketing 87,810 0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 Number of workers 1995 2000 8 90,000 100,000 EXHIBIT 3 Marketing, Research, and Other Employment, U.S. Patented-Drug Makers, 1993-2000 Marketing 87,810 Jobs in U.S. Patented-Drug Firms 90,000 81,296 80,000 67,392 70,000 60,000 50,000 66,223 51,359 40,000 71,374 Production 58,839 60,539 60,207 55,348 49,644 52,066 49,409 50,486 51,002 30,000 R&D 48,527 45,192 Administration 24,166 20,000 Distribution 5,074 10,000 0 1993 Marketing Administration 1994 1995 1996 1997 Production, Quality Control Distribution and Others 9 1998 1999 Medical R&D 2000 EXHIBIT 4 World Pharmaceutical Market, 1999 S o utheast A sia + C hina C anada 6.8% 1.7% M iddle E ast 2.0% Latin A m erica 6.5% U nited S tates 41.3% Japan 15.9% A frica 1.3% E uro pe 23.5% A ustralasia 1.0% Source: IMS Health data cited in PhRMA, Pharmaceutical Industry Profile 2001, July 2001, Chapter 7, Figure 7-2. 10 EXHIBIT 5 Prescription Drug R&D Financed by Wealthy Nations' Drug Makers: National Shares of 8-Nation Total Spending, 1997 United Kingdom 7.6% Sweden 3.3% Italy 3.3% United States 39.1% Japan 20.7% Switzerland 5.4% Germany 10.9% France 9.8% Source: Calculated from data cited in PhRMA, Pharmaceutical Industry Profile 2001, Chapter 7, Fig. 7-1. 11 EXHIBIT 6 Health Spending, GDP, Population, and Industry-Financed Drug Research: U.S. Share of Total for Eight Leading Nations, 1997 HC$ 59.5% GDP 47.3% Pop. 40.1% R&D 39.1% 0% 10% 20% 30% 40% 50% 60% U.S. share of combined total for U.S., France, Germany, Italy, Japan, Sweden, Switzerland, United Kingdom Total health care expenditures Gross Domestic Product (1998) Population Rx R&D financed by nation's drug companies (calculated from industry data) Source: OECD, and research shares calculated from data cited in PhRMA, Pharmaceutical Industry Profile 2001, Chapter 7, Fig. 7-1. 12 70% EXHIBIT 7 Merck Firm-Wide and Pharmaceutical Segment Return on Revenue, 1999 0% Published % return on revenue company-wide Pharmaceutical segment profit as % of segment revenue 10% 20% 30% 40% 50% 60% 70% 26.3 37.4 Return on Revenue 13 80% 90% 100%