Answering Critics of the Pharmaceutical Industry

Answering Critics of the Pharmaceutical Industry
July 1, 2001


Complaints about prescription drug prices have escalated in recent months. Critics contend drugs cost too much and point to drug company profits as the reason why. They also claim the pharmaceutical industry is our nation's most profitable, and that price controls would make drugs more affordable—especially for seniors—as they appear to in Canada and some other developed countries.

As is true in most public policy debates, the issues are far more complex than the critics would make them out to be.


Most Profitable Industry?

The pharmaceutical industry, on the whole, is profitable. But some drug companies lose money, and many non-drug companies make more than drug manufacturers do.

The profitability claim comes from Fortune magazine's annual survey of the top 1,000 companies. According to the most recent survey, published in April 2000, the drug industry's median profit—the middle point between the most and least profitable of the 12 drug companies included—was 18 percent (profit as a percent of revenue) in 1999. Among drug companies, Amgen had the highest profit at 33 percent, with American Home Products the lowest, having lost 9 percent. Most companies reported profits in the range of 15 to 20 percent.

However, many companies that spend far less on research and development make more money than even the most profitable drug companies. Nabisco, for example, reported a 36 percent profit in 1999, according to Fortune. As the accompanying figure shows, Coca-Cola—which produces a product that is competitively priced and very affordable—had higher profits than the drug industry median for most of the 1990s.

Gannett, publisher of USA Today, made 17 percent—right up there with the drug companies—and Tribune, a media conglomerate that includes the Chicago Tribune, the Los Angeles Times, and a number of broadcasting stations, made 46 percent profit, according to Fortune.

Software companies are important to this discussion because they, like the drug companies, are New Economy companies. They both make knowledge-based products and spend a lot of money up front researching and developing those products.

Pharmaceutical companies spent about $24 billion developing and testing new drugs in 2000—about 21 percent of their sales, more than any other industry and twice as much as the computer software industry. However, although software companies spent less than drug companies on R & D, Microsoft reported a 39 percent profit last year, while BMG Software reported 28 percent.


Charging High Prices?

While total spending on pharmaceuticals has been growing rapidly, averaging a 13.7 percent annual increase between 1995 and 1999, most of that spending is due to an increase in new products and volume of sales, not higher prices.

For example, while prescription drug sales grew by 18.8 percent in 1999, 14.6 percentage points of that growth was due to increased volume and new products, while only 4.2 percentage points of the increase was due to higher prices.

Drug companies aren't profitable because they charge so much; they're profitable because they make products that patients and their physicians want.


Patents Protecting Profits?

In many other industries—the soft drink industry, for example—copyrighted, patented, or trademarked products compete strongly, are heavily advertised and priced low, and still their manufacturers earn high profits. But nobody bemoans that fact . . . because they aren't prescription drugs.

The drug industry is highly competitive. No drug company has more than 7.2 percent of the U.S. market. For example, among the top 20 advertised prescription drugs in 1998, four were competing allergy medications.

True, the prescription drug market doesn't work exactly like a normal market, but that's primarily because physicians, who don't have to pay for the drugs, issue prescriptions for patients, who are usually insulated from the cost of drugs by their insurance.

The prescription drug industry could be even more competitive than it is today—which would have a price-lowering effect—if the industry faced fewer regulations, and if consumers demanded value for their drug dollars. Both are possible, but only if policy changes are made.


Advertising Effects?

Every Sunday newspaper is filled with advertising flyers for department stores, office products, computers, cars, food, and clothing. Yet no one complains they can't afford food because the grocery stores advertise. And does anyone really think they would be able to get a computer for less money if none of the computer manufacturers and retail outlets advertised?

Drug companies are increasingly advertising direct-to-consumer (DTC). In just 10 years, spending on DTC advertising by pharmaceutical companies has increased from $55 million (1991) to an estimated $1.8 billion in 2000. Most of that growth came after 1997, when the Food and Drug Administration (FDA) loosened its restrictions on DTC ads.

Critics claim advertising spending drives up the cost of drugs. In fact, those ads create more informed consumers and eventually may lower drug costs.

Prior to the change in FDA guidelines, 41 percent of the physicians surveyed by IMS Health said they had observed an increase in patients' requests for brand-name drugs. After the change, 65 percent of the physicians surveyed noticed an increase in brand-name requests.

That is precisely the type of consumer behavior we want to encourage. Increasing consumer awareness, information, and demand is the first step in the market process that eventually can lead to price competition among drug manufacturers.


Price Controls as a Solution?

Many critics of the drug industry contend that the quickest, most effective way to ensure Americans have access to affordable prescription drugs is to impose price controls, as many other industrialized nations, including Canada, have done.

While it is true that residents of countries with prescription drug price controls pay less for some drugs, they pay more for others . . . if they can get them at all. For example, an April 1999 comparison of drug costs in several countries by Prof. Patricia M. Danzon of the University of Pennsylvania's Wharton School of Business found that "Canadian prices are between 13 percent lower and 3 percent higher than the U.S., depending on the price index used." Moreover, generic drugs, which make up 45 percent of the American prescription drug market, tend to cost more in Canada than in the U.S.

However, the biggest problem may be access. According to Dr. William McArthur, a Canadian physician and formerly the chief coroner in Vancouver, between 1994 and 1998 the Canadian government considered some 400 new drugs but "ruled that only 24—or 6 percent—were substantial improvements over their predecessors."

In addition, each of the 10 Canadian provinces has a review committee that must approve any new drug for the province's formulary. "Of 99 new drugs approved by the federal government in 1998 and 1999, only 25 were listed on the Ontario formulary," according to Dr. McArthur.

Since Canadians must pay out-of-pocket for unapproved drugs, demand is low, and pharmacies have little incentive to stock them. As a result, many Canadians travel to the U.S., paying out-of-pocket to get the drugs they need.


Conclusion

While it is true that many prescription drugs are expensive, those drugs and the millions of dollars in research that created them benefit millions of Americans every day. If we want that research to continue, we must realize that drug company profits aren't a problem—they're the solution.


Merrill Matthews Jr., Ph.D., is a visiting scholar with the Institute for Policy Innovation, policy director for the American Conservative Network, and an associate editor of Health Care News.