KEY POINTS: According to the West Health Policy Center large pharmaceutical manufacturers could endure significant revenue reductions, including the reductions considered in recent legislative proposals, while maintaining current research investments and still achieve the highest returns of any market sector.
One of the principal arguments against reducing pharmaceutical industry profits is that lower profits will lead to less investment in early-stage research and discovery, harming the pipeline for future drug innovation. This argument, however, does not differentiate between investment in companies that engage in early-stage development and companies that focus on bringing promising therapies to market. According to the Government Accountability Office, “traditionally large companies are increasingly relying on mergers and acquisitions to obtain access to new research and are conducting less of their own research in-house.”
Across the study period, large pharmaceutical manufacturers have the highest average ROIC of any industry group. In fact, in nearly every year of the period, pharmaceutical manufacturers’ ROIC leads all other industry groups. Overall, large pharmaceutical manufacturers see a period ROIC of 17.3%, compared to an unweighted average of 11.5% across all other industries (excluding large pharmaceutical manufacturers). This high ROIC among large pharmaceutical manufacturers suggests that a reduction in profit may not lead institutional investors to shift funds to other industries.
Recognizing that large pharmaceutical manufacturers have a greater ROIC than other industries, an important consideration for policymakers is the magnitude of profit loss that large pharmaceutical manufacturers could sustain while maintaining a higher or equal ROIC compared to other industries. We model the profits that large pharmaceutical manufacturers could lose and still achieve an ROIC over the period of 15.3% (greater than all other industries), 13.5% (greater than 75% of other industries), and 11.5% (the average of all industries, including large pharmaceutical manufacturers). To determine the change in profits that would achieve each lower ROIC, we first multiplied the ROIC thresholds by the total invested capital among large pharmaceutical companies over the period to determine profit loss associated with lower ROIC.
We find that over the projected 10-year period from 2020-2029, large pharmaceutical manufacturers would be expected to earn $2,283.2B in profit on $9,940.4B in net sales revenue. Of that revenue, large pharmaceutical manufacturers could see $758.1B in revenue reduction and still maintain an industry-leading ROIC of 15.3%. These manufacturers could face a $1,453.2B reduction in revenue and still maintain an ROIC greater than 75% of other industries, while a revenue reduction of $2,235.2B would leave manufacturers with an average ROIC.
Our analysis demonstrates that manufacturers could still maintain a revenue level that is attractive to institutional investors without reducing current expenditures for research and development. This finding rebuts the argument that recent legislative proposals drastically harm innovation whether through venture capital investment in early-stage research or in-house research investment. While we recognize that any reduction in revenues will change a company’s operational strategy, we find that large pharmaceutical companies would still maintain industry-leading returns on capital even with lower revenues and constant operating expenses. Even with lower revenues, large pharmaceutical companies would still present one of the best investment options for institutional investors, undercutting the notion that capital would flee to other industries and that large pharmaceutical companies would be unable to significantly reward venture capital investments in early-stage research.
Is there any doubt that pharma companies continue to waste a lot of money and that the belt-tightening is needed? How many times have pharma companies wasted money ny sending out sales aids that arent’ used? How long can the industry invest in a sales force that is becoming extinct?
No doubt that PhRMA will take issue with this study but, to be honest their argument is moot as they are nothing but the paid propaganda arm of the industry. CEOs should be preparing their organizations NOW so they can better compete in the near future.