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Marketing And R&D, Again

The BBC has an article posted with the title “Pharmaceutical Industry Gets High on Fat Profits”, so at least you know where that one’s going. And it reads just as you’d expect – if you haven’t had enough pharma-bashing recently, that’ll provide you with all you need.
It contains a chart of marketing expenses, per company, provided by a firm called Global Data. First, the numbers. In this post, I noted that Pfizer spent $7.9 billion on R&D in 2012, and estimated (based on a more solid number of $0.6 billion on direct-to-consumer ad spending) that they’d spent around $5 billion on marketing. For 2013, Pfizer’s R&D expenses were down to $6.5 billion (ugh), but Global Data has their marketing as $11 billion instead. I note from their earnings statement that Pfizer’s entire “Selling, Informational, and Administrative” expense number was $14.2 billion, so Global Data has 77% of that as the marketing budget. That statement doesn’t jibe with, say, Pharmaceutical Executive‘s annual “Industry Audit”, which claims that marketing expenses are a “relatively low” portion of those sorts of overhead figures. No doubt the Global Data people have their own ways of calculating things, and I’d be glad to get more details.
But both R&D expenses and SG&A expenses are high in the entire health care sector. If you look at the ratio of total overhead (those two together) to sales, Pfizer last year comes out to overhead as about 40% of sales. And that’s right at the median for the entire health care sector – that last link shows vividly that the ratios for the health care, financial, and IT sectors are way higher than other industries. (That’s also addressed in this post).
But let me go from arguing the numbers to another point, one that I’ve made many, many times, and that is not addressed in the BBC piece at all. Let’s just stick with Pfizer: they had $51.6 billion dollars of revenue last year. Even if they did spend $11 billion on marketing, the reason that they did so was the this marketing was supposed to bring in more than $11 billion dollars of revenue. Marketing is supposed to make money. If Pfizer had done no marketing whatsoever, they would, presumably, have brought in substantially less revenue.
And what would that have done to the R&D budget? The R&D/sales ratio is called “R&D intensity”. Pfizer’s ratio last year was 12.6% of sales. Apple’s R&D/sales ratio, on the other hand, is a bit below 3% (which is, to be fair, surprisingly small). Google’s ratio is 13.3%, and Microsoft’s is 13.1. IBM is 6.2, and 3M is 5.6%, to give you some other big-tech comparisons.
So if Pfizer’s marketing department pulled its weight, which it had better have done, then they brought in more than 11 billion dollars of that 51.6 figure. Let’s assume that they only brought in 12 billion, and be really conservative about it. Without that, Pfizer’s revenues are 39.6 billion. Are they still going to have an R&D budget of 6.5 billion with those sales, for an R&D/sales ratio of 16.4%? They are not. Hardly anyone can sustain that kind of R&D spending. Even if they stuck with the same ratio they have now, that would take Pfizer’s R&D spend down to $5 billion, an 11% cut, which would be pretty unkind.
My point is that you can’t just point at marketing expenses and start crying foul unless you understand what marketing expenses are, and what they’re for. This point, though, seems largely ungraspable to the wider journalistic world.
Update: The folks at Global Data have written me, noting that (1) I had their name wrong (corrected), and that (2) they feel that the BBC piece does not represent their numbers correctly. Their numbers are “sales and marketing spend”, not “marketing spend”, and they’ve asked the BBC to correct the article. I’ll be revisiting this topic shortly.

53 comments on “Marketing And R&D, Again”

  1. DrugA says:

    Your point that marketing increases revenue is not lost on critics, who see that marketing as being wildly successful in driving up sales of products that are more expensive but no better than older therapies. To wit, a certain proton pump inhibitor that has been one of the world’s best selling drugs for years. Critics also see lawsuits settled year after year for such things as marketing atypical antipsychotics for use in sedating elderly nursing home patients. So, no argument about the revenue implications, but some concern that marketing undermines evidence-based medicine, at substantial cost to society.

  2. Hap says:

    People, rightly or wrongly, correlate increasing advertising expenses to an increasing lack of substance in what you’re selling – if you can increase sales enough to justify a hefty marketing budget, then the reasons that marketing budget is moving product probably aren’t rational analyses of cost and benefit.
    In general, I assume that if a drug company is advertising something, chances are I don’t need it – either they want me to buy a name brand drug for a generic when there isn’t enough benefit to convince doctors or insurance to pay, or they’re trying to get usage for something that it may not work on, and in either case, I don’t want it. They could be making sure I renew (as someone said before), but that’s a lot of money to spend on that, or to get people to buy one of a similar set of drugs, but they aren’t cars and can’t be compared like them (and in any case, competing on advertising does me no good at all).
    In addition, the more money that is spent on advertising and the more revenue they are responsibile for bringing in, the more power they have within the company, which probably will hurt R+D, eventually. Of course, it also means that overselling drugs is more likely, which will hose the company and the industry by costing them money and reputation and making it harder (increasing the FDA’s approval barriers) to get more drugs and make money in the future (which of course, doesn’t often matter to sales and marketing people).
    As a secondary note, when people complain about high pharma profits, I assume they mean that they like and need what pharma makes but want it much cheaper, which while consistent with what lots of people want (“I want to make lots of money selling my stuff but I want your stuff for free”), doesn’t make much sense otherwise.

  3. Anonzy says:

    “Marketing is supposed to make money”
    True, but the problem is that that money is spent on bonuses and M&As, not actual drug discovery. If I had to rail against something that’s what I would rail against.

  4. RD says:

    What if Pfizer told their marketing division that it was going to cut their budget by 20%, layoff 20% of its workers and expect them to increase their share of the market anyway? Are we saying that marketing majors are less able to adapt than R&D professionals and that’s why their budget increased?
    Shouldn’t we expect the same commitment to “shareholder value”?

  5. Anonymous says:

    Marketing doesn’t *create* value, innovation does. In fact, if innovation delivered greater benefits than it does, then marketing wouldn’t be needed at all.
    Marketing is the price you pay for convincing people to buy a product they don’t really want in the first place.

  6. annon 2 says:

    Many people look at the direct to consumer advertising as “pushing” drugs into the public. This is what they see in terms of “advertising”, not the “education” of health care workers or those who decide on new drugs being accepted into HMO formularies. Just as you suggest, it assumes that the direct to consumer ads (eg happy couples looking romantically for ED, going to dinner for bladder control, etc). Do companies have data on this, or are they just being convinced that this is what to do by those with large advertising interests? In my humble opinion, a great new drug will almost sell itself, eg great new drugs for Hep C. Consider the following….Gillead has produced many new, novel drugs and combinations in areas of great medical need, and the drugs almost sell themselves. How much direct to consumer to they sponsor? If they do, it’s mostly to direct users to their drugs compared to other drugs for the same disorder and/or on the same target.

  7. entropyGain says:

    The part I find annoying is what is inside the R&D budget. Look more closely and you’ll find a bunch of phase IV marketing studies. Some companies also include acquisitions inside the R&D budget! The “real” R&D expenses are only a fraction of what is reported.

  8. Anonymous says:

    Marketing is critical, because it helps doctors and patients to understand why they need your crappy undifferentiated product that looks like all the generic drugs out there.
    In other words, it’s what you do when you can’t innovate, so you spend more on marketing and less on R&D, so that you can’t innovate, and so you spend more on marketing and nothing on R&D.
    It’s basically a sign that you sell commodities, or will certainly be doing so in the near future.

  9. Anonymous says:

    Marketing is critical, because it helps doctors and patients to understand why they need your crappy undifferentiated product that looks like all the generic drugs out there.
    In other words, it’s what you do when you can’t innovate, so you spend more on marketing and less on R&D, so that you can’t innovate, and so you spend more on marketing and nothing on R&D.
    It’s basically a sign that you sell commodities, or will certainly be doing so in the near future.

  10. A Pharma Scientist says:

    From The Linked Article:
    “Last year, 100 leading oncologists from around the world wrote an open letter in the journal Blood calling for a reduction in the price of cancer drugs.
    Dr Brian Druker, director of the Knight Cancer Institute and one of the signatories, has asked: “If you are making $3bn a year on [cancer drug] Gleevec, could you get by with $2bn? When do you cross the line from essential profits to profiteering?”
    Oncologist’s salaries being what they are, I wonder when they feel they cross the line from essntial profits to profiteering? On a wider scale, I wonder about all healthcare costs associated with hospital care? Why single out pharma?

  11. A Pharma Scientist says:

    From The Linked Article:
    “Last year, 100 leading oncologists from around the world wrote an open letter in the journal Blood calling for a reduction in the price of cancer drugs.
    Dr Brian Druker, director of the Knight Cancer Institute and one of the signatories, has asked: “If you are making $3bn a year on [cancer drug] Gleevec, could you get by with $2bn? When do you cross the line from essential profits to profiteering?”
    Oncologist’s salaries being what they are, I wonder when they feel they cross the line from essntial profits to profiteering? On a wider scale, I wonder about all healthcare costs associated with hospital care? Why single out pharma?

  12. outtaworkchemist says:

    If you have a good product it will sell itself.

  13. Anonymous says:

    It’s a case of the Prisoner’s Dilemma:
    If no drug company spent money on advertising then drugs would sell according to their profile.
    But then one company wants to squeeze some small advantage so they “invest” in marketing to gain a larger share.
    Then their competitor responds by advertising to defend, and then increase its own share.
    And the cycle repeats until everyone has wasted billions on marketing, but the total value they offer in terms of patient benefits, as well as their share of the market, remain unchanged.
    Thus, marketing is basically destructive competition that destroys net value, unlike innovation which is constructive competition that creates value.

  14. Jack Scannell says:

    There is an unfortunate paradox for the drug industry. Using accounting measures, it looks extremely profitable; the most profitable industry in the world. However, there is also serious doubt in the minds of some investors as to whether financial returns on R&D are above the cost of capital for the average player in the industry. If you simplify an average (i.e., failure-adjusted, etc.) drug lifecycle (of the kind published by Vernon, Grabowski, and DiMasi on various occasions) you can treat R&D as one big lump of cash spent 6 years before drug launch, and the subsequent profits as one big lump of cash received 10 years after the launch of the drug. This is a bit like a financial bond, with money invested for the long run, and then a single lump-sum payment in return. If investors demanded an 8% real (i.e. inflation adjusted) return on the cash deployed in R&D (and this is a low estimate given biotech costs of capital), then for every dollar of R&D cash spent they would need to see, 16 years later, an inflation adjusted cash return of $3.42 (which is (1 + 8%) to the power of 16). So unless the drug industry as a whole looks very profitable on accounting measures, it is effectively losing money on its R&D investment.

  15. Anonymous says:

    …which is why share prices have remained flat for 15 years, and revenue growth has slowed in a linear fashion, about to hit zero and negative territory. The industry is entering a death cycle of terminal decline as its core business model of innovation no longer creates value, and nothing else the industry tries (BD&L, M&A, etc.) does either.

  16. DCRogers says:

    A seamier side to DTC marketing is as a way to create off-label demand — coaching ‘ask your doctor’ from patients is a way around the banned practice of having drug reps counsel off-label prescriptions.
    Late-night TV is lousy with such DTC ads sandwiched between ads recruiting for drug side-effect lawsuits — cause and effect.

  17. Nick K says:

    It would be fascinating to see how spending on marketing has changed over time. I suspect (though I have no data) that marketing budgets were proportionally lower during the good years of Pharma than they are now. In other words, this is a symptom of a failing business model.

  18. Anon2 says:

    @11. A Pharma Scientist
    I agree. Heck, even nurses are doing better than many scientists (especially those who are spending time on a bench). At a local non-profit hospital our nurse anesthetists have a 180k base salary (a local newspaper has an online database of our state salaries through a freedom of information act).

  19. mk says:

    @5: no, it is marketing that creates value. Innovation creates IP, which is no more and no less than an opportunity, or potential value. Innovation without marketing is useless.

  20. Anonymous says:

    @18 – No, they actually spent proportionally much less on R&D, only slightly less on marketing.
    But given the lack of innovation that’s an even greater sign of a broken business model.

  21. mk says:

    @5: no, it is marketing that creates value. Innovation creates IP, which is no more and no less than an opportunity, or potential value. Innovation without marketing is useless.

  22. Anonymous says:

    @23: Then go sell sand! Let’s see how far your marketing takes you there. 🙂

  23. Hap says:

    @21,23: No, R+D (research and development) creates drugs, not only IP – if they’re only creating IP, the company’s either a patent troll (mostly) or dead. Research can lead to IP, but if you only have IP you don’t have anything to develop, or sell. If you have no products, you have no business. Marketing can sell air for only so long before it (and everyone else in the company) goes away.
    Sometimes, even good drugs need marketing, but mostly, for the diseases people are willing to pay for drugs to cure, and in the absence of utility, marketing doesn’t do squat (*cough*Provenge*cough*).

  24. Anonymous says:

    @21/23: I suggest you do a controlled experiment:
    Take all the money that Gilead didn’t need to spend on advertising its incredible Hep C cure, and spend it on trying to sell water for the treatment of Hep C. Let’s see who, you or Gilead creates more value. R&D or marketing?
    Besides, I think Gilead could get a good chunk of money (i.e., *value*) just by selling its IP to another Pharma company, without spending a penny on marketing and sales. Right?
    Point proven. 🙂

  25. Nick K says:

    #19: Thanks for that. According to the graph, SG&A has increased from about 30% to 40% from 1975 until 2005. Unfortunately, the SG&A is a bit too broad as a category, and doesn’t separate out the actual marketing budget.

  26. Anonymous says:

    R&D creates value, marketing milks it. Simple.

  27. Anonymous says:

    R&D produces critical IP without which the entire endeavor is useless. Marketing extracts maximum profit from that IP. Both are critical to sustaining a for profit enterprise. There now is everyone happy?

  28. Anonymous says:

    @29: No, not happy, because marketing only extracts maximum profit from IP *assuming* that nobody else is marketing. When everyone is marketing against each other, it’s destructive competition. The customer receives no overall benefit that wasn’t there without marketing.

  29. Anonymous says:

    Two words: Nash equilibrium
    I.e., everyone loses together by trying to win as an individual.

  30. But says:

    “Even if they did spend $11 billion on marketing, the reason that they did so was the this marketing was supposed to bring in more than $11 billion dollars of revenue. Marketing is supposed to make money. If Pfizer had done no marketing whatsoever, they would, presumably, have brought in substantially less revenue.”
    The problem with this line of thought is that it is completely speculative. What metrics can we look at to determine how much actual value marketing is bringing to the company?

  31. Anonymous says:

    The simple question to ask is:
    Does each dollar spent on marketing create more than 1 dollar in additional revenue for the market *as a whole* – rather than just taking market share from competitors?
    If not then value is being destroyed.

  32. Anonymous says:

    No no no, creating IP leading to an approved drug may be worth 10 billion in aggregate over the lifetime of the patent. However none of that is realized without marketing.

  33. Anonymous says:

    @4: Complete rubbish! If you have a confirmed outright cure for cancer, the word would spread like fire, without any marketing whatsoever.
    Marketing is the price you pay for having a boring product that nobody wants to talk about.

  34. Anonymous says:

    @34 (not 4, sorry): Complete rubbish! If you have a confirmed outright cure for cancer, the word would spread like fire, without any marketing whatsoever.
    Marketing is the price you pay for having a boring product that nobody wants to talk about.

  35. kyosce says:

    I see this as people picking up on the subtle difference between:
    1) making money to create new medicines (A business has to earn enough money to cover costs of doing business.)
    2) creating new medicines to make money (Earning as much money as possible from your product. $100 will cover costs, but why not charge $150?, why not $500?, etc. up to what the market will bear.)
    The second attitude toward selling therapeutic treatments of disease has the unpleasant smell of extortion to it.
    Direct to consumer advertising makes Pharma appear to be in the second category, trying to squeeze every extra dollar out of a product, limited only by the ability to persuade sick people to pay.
    And that makes us an easy target for journalists to bash.

  36. Jack Scannell says:

    In response to @18, marketing spend (or rather, SG&A, as companies don’t break out ‘marketing’ as a specific item) has been flat to decreasing slightly over time as a % of sales, and R&D has been increasing. In the “golden age” of drug discovery, companies spent proportionately less on R&D than they do today. I think that in 1962, the average US big pharma company spent around 6% of sales on R&D, and about 33% of sales on SG&A. By 1982 it was still around 6% on R&D, with 35% on SG&A. By 1992 it was 10% and 36%. By 2002 it was 13% on R&D and 32% on SG&A. Today R&D is around 16% of sales for the average big drug company. I don’t have the SG&A figure at hand. Overall profit margins for the industry have risen since the early 1980s, but that is because COGS has fallen (as a result of rising real terms drug prices, among other things). My sense is that market growth and real term drug price increases from the early 1980s pulled lots more money into R&D (investment chasing returns) which caused the increase in R&D spending as a % of sales.

  37. Simone B says:

    Seriously question the assumption that marketing increases sales by enough to cover its costs. Would be interested to see increase in viagra sales compared to cost of recent glut of DTC ads objectifying half the population.

  38. Hap says:

    @34: No, IP doesn’t make you money without a drug (unless someone else makes one and licenses your IP). And marketing doesn’t contribute anything to the ability to make money from that IP – it’s irrelevant until you have a drug. Marketing is probably involved in determining what segments of the population in whom your drug may work would make an appropriate and lucrative market for it, and marketing can figure out how best to sell it once it exists, but without the drug, they don’t have anything to do. Unless there’s successful development (somewhere), there’s nothing to sell.
    Drugs aren’t thneeds, or at least they’re not supposed to be.

  39. cynical1 says:

    In the case of human disease, pharma is selling a product that is more or less required. Interesting that I don’t see generics competing through advertising with each other for the same product. Or have I missed something?
    Also, I feel that the industry crossed a line when it went it to DTC advertising. Prior to that, there was disease awareness ads. Let’s say you do have ED and you don’t know there’s a treatment. Then that advertising might bring an incentive to go to your doctor to seek treatment. But, (in theory) only can your doctor determine if a medicine would be appropriate for a particular patient based on their medical history. Doctors are also lazy (and stupid) though. And all the studies showed that patients who specifically asked for a particular medication for their ailment were most likely to get that particular prescription. Therefore, DTC took over where intelligent prescribing should have determined prescription sales. I’m sorry but I see DTC advertising of drugs as a failure of the MD community. Since when should they have let the laymen or a drug sales person determine what to prescribe? But they did and it worked. Perhaps we can point a finger, at least briefly, in their direction.
    It doesn’t really matter if I drive a Prius or a Hummer to work as long as I can get to work. Give me the wrong medicine with another medicine and I’m a walking time bomb. I might get to work.

  40. Hap says:

    @39: If R+D includes clinical trials, then the increasing costs of trials would require higher R+D to get the same output. At least part of that increased cost is because drugs were sold to people for whom their benefits didn’t make sense with respect to the costs; thus, to prevent that from occurring, the trials have to be larger to get data in people to whom drug companies might sell the drug. Overselling drugs (by marketing) thus imposes costs borne by R+D.

  41. Anonymous says:

    “In the case of human disease, pharma is selling a product that is more or less required”
    That’s debatable, otherwise we wouldn’t have so much marketing.

  42. pharma scientist says:

    I just don’t understand the uproar with pharma marketing. Pharma spends money on marketing because they believe it increases profits. Is there any industry that behaves differently? Even in the healthcare sector – doctors, hospitals, and insurance companies regularly advertise. No one is required to get their putative ED treated just because they saw a viagra ad (and as noted above – MDs really need to step in here and tell patients no. That’s the whole reason we require prescriptions.)
    The issue seems to simply be that pharma companies make too much money. People want their drugs to be safe, effective, and cheap. Pharma should provide a benefit to mankind without reaping undue rewards. Somehow this belief doesn’t apply to every industry.
    Ultimately, one industry will have the highest profit margins. Why shouldn’t it be pharma? Don’t they provide a more important service than the banking industry?

  43. Jim says:

    @#42 cynical1
    You don’t see generics marketing their products because they’re not marketing them to you. They are marketing to pharmacies – you can be certain of that.
    The other part to this whole debate about marketing in general that hasn’t been brought up is whether physicians make solid decisions founded upon evidence-based medicine. Often, they don’t. At the very least it takes a long time for them to do so. If you have a good drug, and you don’t market it to both patients AND physicians, are you doing a disservice to the patient population?

  44. Anonymous says:

    @42: “I don’t see generics competing through advertising with each other”
    There are plenty ads for Advil and Tylenol, which are totally generic medicines – ibuprofen and acetaminophen. They are also available from a vast number of manufacturers, majority of which do not advertise direct-to-consumers, in so far as I can see.
    So yes, there is advertising for generics.
    I seem to recall seeing both Advil and Tylenol on the highest revenue drugs chart compiled at some Uni (Derek posted it here a few years back). This to me seems like a pretty good evidence that DTC advertising does contribute significantly to company income. I would be curious to see though, just how much does the advertising help – how much $ does Advil pull compared to a reasonable store brand ibuprofen, and how does the excess income compare to the advertising cost.

  45. Anonymous says:

    “So yes, there is advertising for generics.”
    That pretty much proves that marketing destroys value, not for any individual company in isolation, but for the industry as a whole, as they benefit individually from their own marketing, but lose together as competitors marketing against each other.
    Nash equilibrium!

  46. The way marketing can add value is by telling people about useful products that they wouldn’t otherwise have known about. If the value of a drug to a consumer is $20, and the price of the drug is $10, then his buying it is a net gain of $10 to society. If it takes $2 of marketing to accomplish this sale, so that the drug costs $12, society is still ahead by $8. Commerce is not a zero-sum game, so things that cost money and increase commerce can be worthwhile.
    This argument applies even though pharmaceutical ads are pretty much uniformly revolting to knowledgeable people. We’re just not the target for the ads; we don’t care to be fed half-truths; but many others need a nice happy misleading picture to be painted for them, or they won’t spring for something, even if they would end up benefiting from the purchase and not regretting it in the slightest.
    Of course I’m ignoring the whole structure where third parties pay for lots of drugs, so people persuaded by marketers get drugs they wouldn’t pay for themselves, resulting in a net loss for society. That’s kind of under the theory that if you build a massive Rube Goldberg contraption to administer health care, you deserve what you get; don’t blame marketers for your own folly.

  47. gippgig says:

    One important point has been overlooked in the Pfizer example given. Yes, Pfizer’s revenue would be $12 billion less without marketing – but their expenses would be $11 billion less so their profit would only be $1 billion less. Even if that entire amount was deducted from R&D it would still only drop to $5.5 billion.

  48. InsilicoConsulting says:

    Having worked in drug research for a considerable time and now in pharma/healthcare business analytics, I can easily see the skew towards the latter. TSometimes, its just nauseating.

  49. simpl says:

    Here an example from the oil industry on business TV this morning: An oil company, Londin, needs a $30/barrel oil price to justify a project, but costs would be $5/barrel to get the oil out of the ground. The difference is the money needed to get the project on line.
    Projects work the same in Pharma, and include up-front costs from both R&D and launch costs (Marketing). A lot of discussion here has been at the level of “If I were the project manager, I wouldn’t do XYZ”. But Pharma projects have a large cost, even if all decisions are ideally addressed.

  50. Anonymous says:

    The best part of this article is: “The cosy world of big pharmaceuticals is under threat like never before.”
    Ha, ha, ha, ha…cosy!
    They obviously have no idea what it’s like to work within pharma.

  51. Kaleberg says:

    I think that allowing direct to consumer drug marketing was a terrible idea, but I know why drug companies feel they have to do it. With long testing periods and limited patent durations, they want to ramp up demand as quickly as possible. They could wait for word of mouth, especially if their drug really is something better, but their exclusivity would run out before market saturation.
    P.S. I’m not surprised Apple has a low R&D ratio. They’re a software company. The cost of replicating software is amazingly low. Apple offloads most of its hardware R&D onto its partners. They rely on Intel and whoever licenses the A[n] chip for processors. They rely on Toshiba or the like to research new displays. They relied on Samsung for solid state disk drives. Their hardware partner takes a risk spending and spends a lot of R&D money, but Apple can promise big volume orders. Look at this most recent sapphire screen bankruptcy. Some company gambled, spent the R&D money, built the factory, but lost. Apple doesn’t have to do a lot of hardware R&D. They just have to convince others to do it.

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