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DBL%20Hendrix%20small.png College chemistry, 1983

Derek Lowe The 2002 Model

Dbl%20new%20portrait%20B%26W.png After 10 years of blogging. . .

Derek Lowe, an Arkansan by birth, got his BA from Hendrix College and his PhD in organic chemistry from Duke before spending time in Germany on a Humboldt Fellowship on his post-doc. He's worked for several major pharmaceutical companies since 1989 on drug discovery projects against schizophrenia, Alzheimer's, diabetes, osteoporosis and other diseases. To contact Derek email him directly: derekb.lowe@gmail.com Twitter: Dereklowe

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June 17, 2010

Checking the Business Ratios

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Posted by Derek

Jim Edwards has a good post up about financial efficiency among the big drug companies. If you plot out their revenue versus expenses (S,G&A), you see that all the big outfits are basically the same (here's an enlarged version of the graph). Abbott's a bit toward the top end of the narrow range, and AstraZeneca's toward the bottom, but there's not much to choose from. This despite several of the companies on the chart having done whalloping huge mergers during the period shown, mergers which were supposed to improve efficiency. As Edwards shows, though, the best that can be said so far is that (in some cases) things have moved from a bit below average all the way up to. . .average.

It's interesting to compare that ratio to those found at other companies and in other industries. The rule of thumb is that a dollar of SG&A is worth three in revenue. The big drug companies look to have ratios of about 3.2 to 3.5 or so. For apples versus oranges comparisons, Pier 1 is at 3, Best Buy is at 4.2, and Dollar General is at 4.4. Tiffany is 2.4, and CVS is an impressive 7.1.

Another thing to check is the trend over a longer time period. This Nature Reviews article suggests (in its table 1) that the overall ratio for all publicly traded drug companies has been deteriorating slowly since 1975, going from above 3 down to 2.6 or 2.7. (And there are indeed some companies who bring down the average - Genzyme, for example, is at 1.9, partly because of its recent troubles, and Shire is around 2 as well).

Another interesting thing is how Amgen is included on the graph. Perhaps it's an artifact, but what it looks like is that the company starts out like a high flier, and gradually sinks into the same mire as the rest of the big pharma companies. Parallels between that and Amgen's real situation are, I hope, coincidental.

Comments (13) + TrackBacks (0) | Category: Business and Markets


COMMENTS

1. RB Woodweird on June 17, 2010 8:23 AM writes...

For those of us who did not minor in economics:

http://en.wikipedia.org/wiki/SG%26A

So - does this mean that those upper management guys will have to return their bonuses?

Permalink to Comment

2. John on June 17, 2010 9:18 AM writes...

Great topic Derek.

From the NRDD article.

"Our results indicate that investments in
R&D have a positive effect on stock prices,
and thus increase a company’s long-term
value, whereas investments in promoting
existing products have a negative effect
on stock prices."

Actually all these guys did was to demonstrate a correlation, which every good scientist knows does not demonstrate cause and effect. Maybe these guys believe Alzheimer's disease causes aging?

I would argue that when share prices are rising due to high investor expectations about the company pipeline, management is likely to see R&D as a highly profitable investment, and increase R&D spending. We all saw this in the early 1990s. In the face of falling share prices due to a weak pipeline, management is likely to pump up sales and marketing to try to beat the Street's revenue and earnings estimates and thus distract attention from the longer term pipeline issues. This is unfortunately our current situation.


Permalink to Comment

3. Rocky on June 17, 2010 9:21 AM writes...

I'm no expert on this sort of thing but isn't this exactly what would happen as we reach a state of 'pure competition' a la Porter's five forces? Not only should the rev/cost ratio of separate pharmaceutical firms converge, it should also get closer and closer to one.

Very interesting that mergers seem to make very little difference in increasing your ratio. Perhaps companies had to to maintain their 'average' ratio of 3? I'd be interested in looking back further, especially to see what happened after Pfizer's big acquisitions of Warner-Lambert and Pharmacia.

Post is very much appreciated. Thanks Derek!

Permalink to Comment

4. john on June 17, 2010 9:31 AM writes...

I think its hard to see the effect of cost cutting on the type of graph that Jim posted. In the most extreme case you are going to cut your costs post merger by 10% or so. So your ratio of revenue to expenses would maybe drop from 3.3 to 3.0. It gets lost in the noise.

A more interesting graph would have been the ratio of profits to SG&A over time. If you operate at a 10% profit margin and you cut your costs by 10%, every dime of savings goes to the bottom line and you double your profits. And profits are what matter to investors.

Permalink to Comment

5. john on June 17, 2010 9:34 AM writes...

Sorry, that second sentence should have read "...your ration of revenue to expenses would increase from 3.0 to 3.3"

Permalink to Comment

6. PorkPieHat on June 17, 2010 9:46 AM writes...

This is interesting. I think John has it right about looking at profits, however. And what's going on with the 4Q effect, where you see a dip at the end of each year?

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7. PorkPieHat on June 17, 2010 9:48 AM writes...

And what's Abbott doing differently at the end of the year that its numbers dont dip?

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8. Anonymous on June 17, 2010 10:03 AM writes...

"And what's going on with the 4Q effect, where you see a dip at the end of each year ?"

Xmass bonus for CEO and like ?

Permalink to Comment

9. HelicalZz on June 17, 2010 10:25 AM writes...

I've probably linked this here before, but a good assessment of the business of pharma is contained in this 65 page 2006 report from the Congressional Budget Office.

http://www.cbo.gov/ftpdocs/76xx/doc7615/10-02-DrugR-D.pdf

Don't eye roll, this is a very well put together industry assessment loaded with pharmacoeconomic references and considerations. It includes industry historical metrics and some comparisons with other research oriented fields. The report also considers federal R&D spending as an aid / competitor to private spending. It handles this quite well and objectively, introducing considerations that may well be new to many.

Very much recommended to those who haven't already seen it.

Zz

Permalink to Comment

10. ex-Amgenite on June 17, 2010 11:34 AM writes...

Based on insider experience, I can tell you that Amgen's chart behavior does indeed parallel its real situation. The "red" and "white" franchises have progressed beyond maturity into old age. Enbrel sales remain strong, but most of the margin goes to Pfizer-Wyeth due to the structure of the Immunex acquisition. No organically derived blockbusters in 10+ years (Prolia will hopefully break this trend). Huge internal investment in small molecule R&D with zero return to date. Amgen has indeed morphed into the big pharma of biotech.

Permalink to Comment

11. john on June 17, 2010 2:08 PM writes...

thanks for the link HelicalZz!

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12. Morten G on June 17, 2010 8:12 PM writes...

Besides looking at profits like John said a comparison with mid-sized, 5k-50k employees pharmas would be interesting. Just to see if smaller pharma is more efficient (they should be leaner right?).

Permalink to Comment

13. Morten G on June 17, 2010 8:34 PM writes...

Argh, right there at the end of his article. Embarrassing.
Okay, more than just Gilead then please. Novo, Takeda, Daiichi, Forest, etc. (http://en.wikipedia.org/wiki/List_of_pharmaceutical_companies) Actually from that link I just need to dig up some SG&A costs and I could do it myself. Or I could do some actual work. Decisions, decisions...

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