From Quora:
“Excessive” is loaded term. Worse, it’s subjective and difficult to define. Let’s see if we can put it into some kind of context or framework that permits a useful discussion.
Congress, always sensitive to public resentment over drug prices, had the GAO do a study on drug company profitability. The 1-page summary, which you should definitely read, states that
Retail prescription drug expenditures were estimated to account for about 12 percent of total personal health care service spending in the United States in 2015, up from about 7 percent through the 1990s. Much of this growth was driven by use of expensive brandname drugs, but price increases have been reported for some generic drugs as well. Prior GAO reports have identified multiple reasons for drug price increases, including limited competition. Experts have questioned whether consolidation among drug companies could reduce competition and R&D investment in new drugs
OK, but how do drug company profits stack up to other industries? One way to put some meaning into the term “excessive” is to ask how profitability for drug companies compares to that of other industries. If it is similar, then it’s hard to conclude that pharmas are making excessive profits, unless you think that most companies make excessive profits. We can’t objectively define “excessive” but we can define “normal”. Here’s the key figure from the GAO report:
The largest drug companies are exceptionally profitable: they have a profit margin of about 18%, vs maybe 8% for other large companies. The GAO included software as a comparator because these companies also have high R&D costs and low manufacturing costs. Software looks to be even more profitable than pharma.
Other analyses come to much the same conclusion. This independent analysis breaks down profit margins with more granularity:
From Stock Market Briefing: S&P 500 Sectors & Industries Profit Margins
Case closed then. Drug companies make profits at 2–3X the level of companies in other industries. That meets any reasonable definition of “excessive profit”.
But we shouldn’t get too comfortable with this conclusion. The data above are for the big companies – the top 25, and the S&P500 drug companies. Those companies are by definition successful, and may not be representative of the industry as a whole. It could be much like using Tom Cruise and Jennifer Lawrence to judge how much money one might make in an acting career.
This article claims that of 286 publicly traded biotech companies in 2012, only 28 (12%) had a positive net income:
From Only 12% of Public Biotechs are Profitable
Not so impressive. Even these numbers are misleading – most biotech startups fail without ever going public, losing tens to hundreds of millions of dollars each in the process. The combination of high initial R&D costs and high failure rates is lethal to getting a return on investment.
I can’t find any numbers to back up this assertion, but I’ll make it anyway: once you factor in the cost of failures, biotech/pharma industry profits are pretty typical of other industries. What’s different is the distribution—we have a few mega-successes that are basically printing money, a fair number that are doing OK, and many more that collectively lose billions. Sort of like acting.
If you look only at the successful incumbents—and the truly egregious behavior in which they sometimes engage—you are tempted to storm the gates and burn down the whole rotten edifice. But if you take a step back and look at the many failures, you are likely to temper this impulse: to curb abusive behavior but otherwise let the system continue as it has for decades.
And if you take a few more steps back, you might conclude that the drug industry in its current form is doomed anyway. Although the prices of new drugs keep rising, the cost to develop a drug is rising faster still. I’ve argued (here and here and here) that the biological model on which pharma is based (that there is an infinity of new drugs to be discovered) is wrong. No industry, no matter how abusive, is dominant forever (just ask the railroads). If you hate the drug industry, as so many do, you will soon have the satisfaction of seeing it fail. Sic transit gloria negotium elit.