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Profitability of Drug Companies

By March 6, 2020Commentary

The current issue of the Journal of the American Medical Association has a variety of articles on the prescription drug industry and drug prices.  One focuses on the profitability of large, publicly held drug manufacturers compared to that of other large companies.   (JAMA Article)   Everyone knows that drug manufacturers charge very high prices for branded medications and that they make a lot of money.  The standard line from the companies is that they need those profits to reinvest in new drugs, which are just so expensive to develop.  This is hogwash.  Nothing gets done about drug prices because the companies have so much money they can buy off politicians from both major parties.  But I digress, the point of the article is to examine just how comparatively profitable the drug industry is.   Data from 2000 to 2018 was gathered from the publicly reported financial information of 35 large drug companies and 357 large public companies in other industries.  During the study period the drug companies had total revenue of $11.5 trillion, with gross profit (profit before operating expenses) of $8.6 trillion , or 74.5% of revenue and net income of $1.9 trillion, or 16.2% of revenue.  For the comparison companies, gross profit was 32.3% of revenue and net income was 7.2% of revenue.  The drug manufacturers had much higher research and development expenses than the comparison group, but also much higher sales and marketing spending.  Even doing the analysis with various adjustments leads to basically the same conclusions.  The drug companies also have much higher margins than other health care sectors, like insurers or providers.

One other thing to carefully note is that when a company is very profitable, it tends to spend more on operating and other costs.  Management and employees get paid more.  Fancier building are used.  More is spent on marketing and sales.  All of that is true of large public drug companies.  And all those increased operating costs may make the company look less profitable.  An interesting analysis would be to say what if the drug companies paid their management and employees consistent with other firms, and what if their sales and marketing expense as a percent of revenue was more like other firms.  I think that analysis would show us just how even more absurdly profitable these companies are.  And what it really shows is that they are just jacking up prices, based on monopolies granted by the government.  That has to change.  And changing it will make no difference in innovation in medicines.  That innovation is largely occurring at academic centers in any event.

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