Chapter 1 of The Truth About Drug Companies by Marcia Angell

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http://www.alternet.org/envirohealth/19540/

 

The $200 Billion Colossus

By Marcia Angell, AlterNet

Posted on August 13, 2004, Printed on August 13, 2004

http://www.alternet.org/story/19540/

 

The following is taken from Chapter 1 of The Truth

About Drug Companies by Marcia Angell, published by

Random House.

 

What does the eight-hundred-pound gorilla do?

 

Anything it wants to.

 

What's true of the eight-hundred-pound gorilla is true

of the colossus that is the pharmaceutical industry.

It is used to doing pretty much what it wants to do.

The watershed year was 1980. Before then, it was a

good business, but afterward, it was a stupendous one.

From 1960 to 1980, prescription drug sales were fairly

static as a percent of U.S. gross domestic product,

but from 1980 to 2000, they tripled. They now stand at

more than $200 billion a year. Furthermore, since the

early 1980s, this industry has consistently ranked as

the most profitable in the United States˜by a long

shot. (Only in 2003 did it fall from that position to

rank third among the forty-seven industries listed in

the Fortune 500.) Of the many events that contributed

to their sudden great and good fortune, none had to do

with the quality of the drugs the companies were

selling.

 

In this chapter I'll give you an overview of the

pharmaceutical industry – its meteoric rise and the

recent, early signs of either a coming fall or an

overhaul. I will not go into much detail here; I'll

leave that to later chapters. What I want to do now is

provide a quick look at what's under this rock when

it's lifted. It's not a pretty sight.

 

Before I begin, a few words about the facts and

figures I will use throughout the book. In most cases,

I use data from the year 2001, because it is the most

recent year for which information is reasonably

complete for all the aspects of the industry I will

consider. If I stick with one year, it will make it

easier to see the whole picture. But for some

important facts, I will use figures from 2002 and,

whenever possible, 2003. In all cases, I will make it

clear what year I am talking about.

 

I also need to explain what I mean when I say this is

a $200 billion industry. According to government

sources, that is roughly how much Americans spent on

prescription drugs in 2002. That figure refers to

direct consumer purchases at drugstores and mail order

pharmacies (whether paid for out of pocket or not),

and it includes the nearly 25 percent markup for

wholesalers, pharmacists, and other middlemen and

retailers. But it does not include the large amounts

spent for drugs administered in hospitals, nursing

homes, or doctors‚ offices (as is the case for many

cancer drugs). In most analyses, they are allocated to

costs for those facilities.

 

Drug company revenues (or sales) are a little

different, at least as they are reported in summaries

of corporate annual reports. They usually refer to a

company's worldwide sales, including those to health

facilities. But they do not include the revenues of

middlemen and retailers.

 

Perhaps the most quoted source of statistics on the

pharmaceutical industry, IMS Health, estimated total

worldwide sales for prescription drugs to be about

$400 billion in 2002. About half were in the United

States. So the $200 billion colossus is really a $400

billion megacolossus, but my focus in this book will

be mainly on how the drug companies operate in the

United States.

 

You should understand, however, that it is virtually

impossible to be precise about most of these figures.

Before drugs reach consumers, they pass through many

hands and are paid for in exceedingly complicated,

often hidden, ways. It is easy to compare apples and

oranges without knowing it. You need to ask, for

example, whether a number refers just to prescription

drugs or includes over-the-counter drugs and other

consumer products made by drug companies; whether it

includes revenues for middlemen and retailers or not;

whether it refers just to outpatient consumer

purchases or also to health facility purchases; and

whether it includes mail order purchases.

 

Let the Good Times Roll

 

The election of Ronald Reagan in 1980 was perhaps the

most fundamental element in the rapid rise of big

pharma – the collective name for the largest drug

companies. With the Reagan administration came a

strong pro-business shift not only in government

policies but in society at large. And with the shift,

the public attitude toward great wealth changed.

Before then, there was something faintly disreputable

about really big fortunes. You could choose to do well

or you could choose to do good, but most people who

had any choice in the matter thought it difficult to

do both. That belief was particularly strong among

scientists and other intellectuals. They could choose

to live a comfortable but not luxurious life in

academia, hoping to do exciting cutting-edge research,

or they could " sell out " to industry and do less

important but more remunerative work. Starting in the

Reagan years and continuing through the 1990s,

Americans changed their tune. It became not only

reputable to be wealthy, but something close to

virtuous. There were " winners " and there were

" losers, " and the winners were rich and deserved to

be. The gap between the rich and poor, which had been

narrowing since World War II, suddenly began to widen

again, until today it is a yawning chasm.

 

The pharmaceutical industry and its CEOs quickly

joined the ranks of the winners as a result of a

number of business-friendly government actions. I

won't enumerate all of them, but two are especially

important. Beginning in 1980, Congress enacted a

series of laws designed to speed the translation of

tax-supported basic research into useful new products

– a process sometimes referred to as " technology

transfer. " The goal was also to improve the position

of American-owned high-tech businesses in world

markets. The most important of these laws is known as

the Bayh-Dole Act, after its chief sponsors, Senator

Birch Bayh (D-Ind.) and Senator Robert Dole (R-Kans.).

Bayh-Dole enabled universities and small businesses to

patent discoveries emanating from research sponsored

by the National Institutes of Health (NIH), the major

distributor of tax dollars for medical research, and

then to grant exclusive licenses to drug companies.

Until then, taxpayer-financed discoveries were in the

public domain, available to any company that wanted to

use them. But now universities, where most

NIH-sponsored work is carried out, can patent and

license their discoveries, and charge royalties.

Similar legislation permitted the NIH itself to enter

into deals with drug companies that would directly

transfer NIH discoveries to industry.

 

Bayh-Dole gave a tremendous boost to the nascent

biotechnology industry, as well as to big pharma.

Small biotech companies, many of them founded by

university researchers to exploit their discoveries,

proliferated rapidly. They now ring the major academic

research institutions and often carry out the initial

phases of drug development, hoping for lucrative deals

with big drug companies that can market the new drugs.

Usually both academic researchers and their

institutions own equity in the biotechnology companies

they are involved with. Thus, when a patent held by a

university or a small biotech company is eventually

licensed to a big drug company, all parties cash in on

the public investment in research.

 

These laws mean that drug companies no longer have to

rely on their own research for new drugs, and few of

the large ones do. Increasingly, they rely on

academia, small biotech start-up companies, and the

NIH for that. At least a third of drugs marketed by

the major drug companies are now licensed from

universities or small biotech companies, and these

tend to be the most innovative ones. While Bayh-Dole

was clearly a bonanza for big pharma and the biotech

industry, whether it is a net benefit to the public is

arguable (I'll come back to that).

 

The Reagan years and Bayh-Dole also transformed the

ethos of medical schools and teaching hospitals. These

nonprofit institutions started to see themselves as

" partners " of industry, and they became just as

enthusiastic as any entrepreneur about the

opportunities to parlay their discoveries into

financial gain. Faculty researchers were encouraged to

obtain patents on their work (which were assigned to

their universities), and they shared in the royalties.

Many medical schools and teaching hospitals set up

" technology transfer " offices to help in this activity

and capitalize on faculty discoveries. As the

entrepreneurial spirit grew during the 1990s, medical

school faculty entered into other lucrative financial

arrangements with drug companies, as did their parent

institutions. One of the results has been a growing

pro-industry bias in medical research – exactly where

such bias doesn't belong. Faculty members who had

earlier contented themselves with what was once

referred to as a " threadbare but genteel " lifestyle

began to ask themselves, in the words of my

grandmother, " If you're so smart, why aren't you

rich? " Medical schools and teaching hospitals, for

their part, put more resources into searching for

commercial opportunities.

 

Starting in 1984, with legislation known as the

Hatch-Waxman Act, Congress passed another series of

laws that were just as big a bonanza for the

pharmaceutical industry. These laws extended monopoly

rights for brand-name drugs. Exclusivity is the

lifeblood of the industry because it means that no

other company may sell the same drug for a set period.

After exclusive marketing rights expire, copies

(called generic drugs) enter the market, and the price

usually falls to as little as 20 percent of what it

was. There are two forms of monopoly rights – patents

granted by the U.S. Patent and Trademark Office

(USPTO) and exclusivity granted by the Food and Drug

Administration (FDA). While related, they operate

somewhat independently, almost as backups for each

other. Hatch-Waxman, named for Senator Orrin Hatch

(R-Utah) and Representative Henry Waxman (D-Calif.),

was meant mainly to stimulate the foundering generic

industry by short-circuiting some of the FDA

requirements for bringing generic drugs to market.

While successful in doing that, Hatch-Waxman also

lengthened the patent life for brand-name drugs. Since

then, industry lawyers have manipulated some of its

provisions to extend patents far longer than the

lawmakers intended.

 

In the 1990s, Congress enacted other laws that further

increased the patent life of brand-name drugs. Drug

companies now employ small armies of lawyers to milk

these laws for all they're worth – and they're worth a

lot. The result is that the effective patent life of

brand-name drugs increased from about eight years in

1980 to about fourteen years in 2000. For a

blockbuster – usually defined as a drug with sales of

over a billion dollars a year (like Lipitor or

Celebrex or Zoloft) – those six years of additional

exclusivity are golden. They can add billions of

dollars to sales – enough to buy a lot of lawyers and

have plenty of change left over. No wonder big pharma

will do almost anything to protect exclusive marketing

rights, despite the fact that doing so flies in the

face of all its rhetoric about the free market.

 

Riding High

 

As their profits skyrocketed during the 1980s and

1990s, so did the political clout of drug companies.

By 1990, the industry had assumed its present contours

as a business with unprecedented control over its own

fortunes. For example, if it didn't like something

about the FDA, the federal agency that is supposed to

regulate the industry, it could change it through

direct pressure or through its friends in Congress.

The top ten drug companies (which included European

companies) had profits of nearly 25 percent of sales

in 1990, and except for a dip at the time of President

Bill Clinton's health care reform proposal, profits as

a percentage of sales remained about the same for the

next decade. (Of course, in absolute terms, as sales

mounted, so did profits.) In 2001, the ten American

drug companies in the Fortune 500 list (not quite the

same as the top ten worldwide, but their profit

margins are much the same) ranked far above all other

American industries in average net return, whether as

a percentage of sales (18.5 percent), of assets (16.3

percent), or of shareholders' equity (33.2 percent).

These are astonishing margins. For comparison, the

median net return for all other industries in the

Fortune 500 was only 3.3 percent of sales. Commercial

banking, itself no slouch as an aggressive industry

with many friends in high places, was a distant

second, at 13.5 percent of sales.

 

In 2002, as the economic downturn continued, big

pharma showed only a slight drop in profits – from

18.5 to 17.0 percent of sales. The most startling fact

about 2002 is that the combined profits for the ten

drug companies in the Fortune 500 ($35.9 billion) were

more than the profits for all the other 490 businesses

put together ($33.7 billion). In 2003, profits of the

Fortune 500 drug companies dropped to 14.3 percent of

sales, still well above the median for all industries

of 4.6 percent for the year. When I say this is a

profitable industry, I mean really profitable. It is

difficult to conceive of how awash in money big pharma

is.

 

Drug industry expenditures for research and

development, while large, were consistently far less

than profits. For the top ten companies, they amounted

to only 11 percent of sales in 1990, rising slightly

to 14 percent in 2000. The biggest single item in the

budget is neither R & D nor even profits but something

usually called " marketing and administration " – a name

that varies slightly from company to company. In 1990,

a staggering 36 percent of sales revenues went into

this category, and that proportion remained about the

same for over a decade. Note that this is

two-and-a-half times the expenditures for R & D.

 

These figures are drawn from the industry's own annual

reports to the Securities and Exchange Commission

(SEC) and to stockholders, but what actually goes into

these categories is not at all clear, because drug

companies hold that information very close to their

chests. It is likely, for instance, that R & D

includes many activities most people would consider

marketing, but no one can know for sure. For its part,

" marketing and administration " is a gigantic black box

that probably includes what the industry calls

" education, " as well as advertising and promotion,

legal costs, and executive salaries – which are

whopping. According to a report by the nonprofit group

Families USA, the former chairman and CEO of

Bristol-Myers Squibb, Charles A. Heimbold, Jr., made

$74,890,918 in 2001, not counting his $76,095,611

worth of unexercised stock options. The chairman of

Wyeth made $40,521,011, exclusive of his $40,629,459

in stock options. And so on. This is an industry that

amply rewards its own.

 

In recent years, the top ten companies have included

five European giants – GlaxoSmithKline, AstraZeneca,

Novartis, Roche, and Aventis. Their profit margins are

similar to those of their American counterparts, and

so are their expenditures for R & D and marketing and

administration. Furthermore, they are members of the

industry's trade association, the misleadingly named

Pharmaceutical Research and Manufacturers of America

(PhRMA). Recently I heard Daniel Vasella, the chairman

and CEO of Novartis, speak at a conference. He was

clearly pleased with the American commercial and

research climate. " Free pricing and fast approval

secure rapid access to innovation without rationing, "

he said, sounding like the most red-blooded of

Americans, despite his charming Swiss accent. His

company is now moving its research operations to a

site near the Massachusetts Institute of Technology

(MIT), a hotbed of basic research surrounded by

biotechnology companies. I suspect the move has

nothing to do with " free pricing and fast approval " at

all, and everything to do with the opportunity to

profit from U.S. taxpayer-funded research under the

terms of Bayh-Dole, and from the proximity of U.S.

medical scientists who do the research.

 

© 2004 Independent Media Institute. All rights

reserved.

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