Deep Thoughts on Big Pharma

Benefits and Problems in the Industry as a Whole

Introduction

I’ve now read a lot about the top five pharmaceutical companies and I feel at least moderately better informed about what appears to be a very complex and fascinating industry.

I wanted to give a little more commentary from a slightly more informed perspective on the good and bad aspects of these massive companies.

Size comparisons

When choosing the top 5 pharmaceutical companies, I chose to do it by market capitalization rather than revenue, earnings, number of people employed or other metrics. To a large extent that was arbitrary. However, I like it as a measure partly because it attempts to bake in the importance of the company in the future as well as the company’s current value. Below I’m just going to show how the rankings would be different if we went with a measure like revenue or earnings:

Top 10 pharma companies by earnings:

(source https://companiesmarketcap.com/pharmaceuticals/)

Top 10 pharma companies by revenue:

(source https://companiesmarketcap.com/pharmaceuticals/)

You can see that the top 5 by market cap, for the most part, are at least represented in the top 10 for earnings and revenue, with the exception of Eli Lilly. Possibly this is the market pricing in the importance of drugs the Lilly produces for the long run, rather than just in the past couple years that were dominated by COVID-19 (I’m thinking about insulin at least?)

It would be interesting to take a look at the CVS and Walgreens of the world in how their businesses compare on pharmaceuticals but they are really another category.

Mostly I just wanted to point out that I made a somewhat arbitrary editorial choice that slightly impacts the way we look at the individual companies, but doesn’t drastically alter the companies profiled or the overall picture of the “Big Pharma” set of companies.

How Big is Big Pharma compared to other Big Companies?

I’m going to use market cap here again for consistency. Here’s the top ~39 or so companies. I highlighted Big Pharma rows:

Big Pharma makes up seven out of the top 36 companies, and only one of the top ten. So it’s pretty big, but not as big as some industries like oil and tech.

Saving lives

First of all, I think it’s important to acknowledge upfront that, without a doubt, pharmaceutical companies produce some drugs that save millions of lives each year and alleviate an incredible amount of suffering.

Many of the top drugs by revenue are for widespread and devastating conditions like cancers and autoimmune disorders.

A lot of people would be leading shorter and more miserable lives if it wasn’t for the large scale discovery of new drugs, the production and distribution of those drugs.

It was really fascinating to read about the histories of the large pharma companies, many of which started as small shops back in the latter part of the 19th centuries by people who were really motivated to make a difference in peoples lives with cutting edge technology

Many of those companies were and still are model employers. Some of them now provide jobs in R&D, manufacturing, sales and distribution for tens or hundreds of thousands of people. Stories of how they tried to keep people employed through the World Wars and the Great Depression were awesome to see.

The COVID-19 pandemic showed how amazing Big Pharma can be, as the companies profiled, and many more quickly discovered, tested and produced hundreds of millions of doses of vaccines, not to mention therapeutics that were used to treat and save the lives of millions were infected.

I’m going to spend most of the rest of this post talking about some of the critiques of these companies, but I don’t want to lose sight of the fact that I think that the large pharmaceutical companies are a large net-positive to the welfare of people on the planet.

However, it is our responsibility as citizens to make the world even better, and part of that responsibility is to check some of the worse impulses and motivations of these large companies while we try to maximize their benefits.

Pricing Controversies

There are a lot of charges of unethical behavior of the pharmaceutical industry around drug pricing. This is a complicated area, where harm can be done perfectly legally but it’s hard to prove the point where it occurs. There are also potentially good reasons to keep prices high to incentivize innovation. I’ll explore some of the issues below.

Incentives:

First of all, I think it’s important to recognize that drug companies have a fiduciary duty to their shareholders to attempt to maximize shareholder value. Often, the way to maximize shareholder value is by setting high prices.

Currently, there are a lot of ways to legally set high prices and thereby drive strong profits and shareholder values. Whereas we would hope that pharma companies would do the right things for their customers out of the goodness of their heart, the way the system works currently doesn’t incentivize this, and in some (or many) cases, it in fact incentivizes the opposite.

In such a system, the companies that will rise to the top of the market will necessarily be the ones to maximize shareholder value, and where there is demand, the market will provide supply.

Why Drug Prices Tend to Get High:

There are a few factors that make drug prices especially prone to get high.

1. Information Asymmetry - patients aren’t doctors, and often don’t know much about whatever condition they are diagnosed with, what the best treatments are, what the risks are, what the costs are and whether they are worth it. So, they rely heavily on their doctor’s expertise. The doctor, however, is not the one paying the bill, so they don’t have the incentive towards cost-effectiveness in their advise. Knowing this, pharma companies often market new drugs aggressively to doctors, and in some cases, they make exaggerated or false claims. Lower cost generic drugs often cannot or do not market as aggressively. Therefore, the information asymmetry and marketing often favors large drug companies with large marketing budgets.

2. Life or Death - It’s easy for arm-chair analysts to say expensive cancer drugs are not worth the exorbitant costs when reviewing the research. It’s another thing for a patient who might die soon. A potential 1% higher chance of living might be worth a lot to a dying person.

3. Complex payer structure - The whole cost of a drug may not be apparent to a patient who decides to use the drug, because a large portion of the cost may be paid by their insurance. A complex web of relationships between pharmacies, insurance companies and employers that often pay for insurance premiums bare the cast. Further complicating the payment structure are the incentives that governments give employers to sponsor their employees health insurance.

Research & Development:

Risk & Reward

There is a legitimate argument that developing drugs is a pretty high-risk endeavor. It takes a lot of research that doesn’t pay off before a blockbuster drug is developed. The argument goes that those high risks are passed on to consumers as high prices for new life-saving drugs. Furthermore, the reason America leads in pharmaceutical innovation is our lack of price controls (a recent version of this argument is here)

However, much of the risk isn’t borne solely by the pharma companies. The National Institute of Health (NIH) pays something like $39 Billion/year in grants for drug research. Pharma companies also get tax breaks for R&D.

In addition to the research funded by the government, a good deal of the drugs marketed by the largest pharma companies are actually discovered by smaller companies and come to Big Pharma from acquisitions as discussed here.

That’s not really to say that Big Pharma doesn’t do anything for R&D. That conclusion neglects the second order effects. Smaller pharmaceutical companies discover new drugs partly in hopes of being acquired by Big Pharma. Academic researcher can also be incentivized by future money from Big Pharma companies.

Patents and ‘Evergreening’

New drugs in the US can be patented so that no other company can manufacture that drug for a period of 20 years. This gives huge incentives for developers of useful new drugs. It also means that a drug company owning a patent has a monopoly for 20 years, and they can set the price without regard to competition.

This is obviously extremely valuable and has led drug companies to try to extend their patents on valuable drugs by finding new uses for the same drug, or by slightly tweaking the formula to get a new patent. This process is called ‘evergreening’ and can keep prices on valuable drugs artificially high.

My Take on Price Controls

With that being the case, my personal take is that pharmaceutical prices are an area where markets don’t function super well and may require some intervention. However, I do think that our lack of price controls do lead to America hosting the lion’s share of innovation as drug companies and conservative policy makers claim.

For those reasons, I think that proposals such as limiting drug price increases to the rate of inflation are a strong over reach, but that allowing Medicare to negotiate drug prices (which passed as part of the Inflation Reduction Act), is the right kind of price control.

With the Medicare changes going into effect, we should keep our eye on how the market reacts and be cautious but ready to make more incremental changes if prescription drug prices continue make the health care goals of Americans difficult to reach.

https://www.americanprogress.org/article/big-pharma-reaps-profits-hurting-everyday-americans/

https://www.bmj.com/content/368/bmj.l4627

https://www.statnews.com/2019/12/10/large-pharma-companies-provide-little-new-drug-development-innovation/

https://www.wsj.com/articles/canada-should-pay-more-for-medications-price-controls-oecd-innovation-prescription-drugs-revenue-prices-pharmaceuticals-11658084406

Overprescribing

Another criticism that is often lodged against the pharmaceutical industry, as well as other parts of the health care establishment, is that they encourage the use of drugs beyond the point of medical usefulness and often to medical harm.

The main charges of culpability are:

1. Advertising drugs to patients - doctors are more likely to prescribe drugs that patients ask for. That’s why pharmaceutical companies run so many ads for prescription medicine, a practice that is illegal in many developed countries

2. Promotion of drugs to physicians - drug companies also aggressively market their drugs to doctors through advertising in magazines and aggressive sales approaches by pharma reps. This can lead doctors to be favorably disposed to prescribe drugs over and above what is clinically helpful

3. Influence over Clinical Practice Guidelines - In some cases, the committees that set the guidelines for medicine prescriptions are directly influenced by pharmaceutical companies

(1) and (2) are legal as long as the messages delivered are accurate, which certainly isn’t always the case.

Sources:

https://journals.plos.org/plosone/article?id=10.1371/journal.pone.0047343

https://www.ncbi.nlm.nih.gov/pmc/articles/PMC6731049/

https://www.statnews.com/2019/04/02/overprescribed-americas-other-drug-problem/

Regulatory capture

Another problem in the pharmaceutical industry is one that plagues any industry that gets sufficiently big. Large companies often know more and certainly care more about regulation and laws that affect them than the general public. Their incentives are to maximize their shareholder value, and they will extend that incentive structure to influence policy making.

Activities that fall into this broad category that we find going on are:

• Lobbying and campaign contributions - thereby swaying lawmakers to make favorable laws for the industry.

• The ‘Revolving Door’- ie public officials that have been favorable to the pharmaceutical industry may receive lucrative job offers from pharma companies.

• Funding favorable academic research - industry may fund research that has findings favorable to their company. For example, they might fund a study advocating for higher dosage or increased use of an expensive, patented drug.

These and other practices can stifle innovation by favoring incumbents who have the resources to influence policy makers.

They can lead to higher prices for consumers by industry resistance to price controls.

In the worst cases, this can lead to direct patient harm by promoting or incentivizing practices that are beneficial to the industry to the detriment of patients.

Sources:

https://rooseveltinstitute.org/2019/05/22/capturing-the-government-big-pharmas-take-over-of-policymaking/

https://pubmed.ncbi.nlm.nih.gov/31933284/

Random observations

• CEOs and other executives tend to rise through the ranks within their own pharma giant

  • I wonder if this might lead to a kind of myopia that has negative effects on the industry. It may occassionally be good to have an outsider view on some of the major business or ethical issues at Big Pharma companies

• 30 years of consolidation

  • In looking into the history of these companies, since the nineties it just seems like a lot of acquisitions and mergers, referencing tax efficiencies and geographies… but mostly Big Pharma is using acquisitions to acquire new lines of drugs, treatments, medical devices or other product lines

  • It has made me wonder if there is much innovation happening within the companies themselves… I’ll explore this a little more farther down.

Conclusions

Big Pharma is one of the biggest industries in the world, though falling below Tech and Oil in value.

The industry has been responsible for innovations, production and distribution of miraculous compounds that have saved and improved millions of lives, and is one of the main reasons we enjoy higher standards of living than ever before.

That said, the incentives of a uniquely distorted market have caused opportunities for profit at the expense of general well being. There are some cases where this is clear cut, and others where the tradeoffs for harm and benefit to public welfare are hazy.

It’s clear to me that industries like this are places where the government should intervene to make sure that public welfare is improved to the greatest extent possible. However, it is a complex system where changes may have second order effects that aren’t understood, so policy makers should tread carefully and build incrementally on previous successful policies rather than risk large changes that could make things worse.