Merck CEO Frazier finds fault in new studies suggesting pharma profits are too high

Is the pharma industry hiking up drug prices to boost profitability at the expense of hardworking Americans? That question—a favorite of politicians on both sides of the aisle—is at the heart of a special issue of the Journal of the American Medical Association, which features a collection of articles that aim to provide a well-rounded answer.

Perhaps the most damning of the studies compares the profits of the 35 biggest pharmaceutical companies to the S&P 500 as a whole. The study, led by Bentley University, found that between 2000 and 2018 the median annual gross profit margin of Big Pharma was 76.5%, versus just 37.4% for the S&P 500 companies. Earnings before taxes and net income margins were also significantly higher among pharma companies, the authors reported.

Separate studies found that the median cost of bringing a drug to market is $985 million and that the net prices of drugs in the 10 years ending in 2018 rose 60%. All in all, the studies “paint a concerning picture about the relationships among rising drug prices, pharmaceutical industry profits, uncertainty about pharmaceutical R&D costs, and lobbying and political donations to gain influence with legislators,” Yale Law School professor Deb Chaarushena and JAMA deputy editor Gregory Curfman wrote in an accompanying editorial.

Merck CEO Kenneth Frazier had his own set of worries about the new JAMA studies, though he was more focused on fairness—or lack thereof.

In an editorial, Frazier explained that the study estimating the cost of bringing a drug to market was performed using financial disclosures from publicly traded companies. But most large companies report total R&D expenses, not product-by-product expenses, meaning the analysis was likely “enriched with niche drugs that are dissimilar from the broader population of drugs approved by the US Food and Drug Administration (FDA) during the last decade,” Frazier wrote.

What’s more, the authors factored in the cost of research failures by dividing expenses incurred during each phase of clinical trials by the estimated probability of that phase having a successful outcome. Problem is, that makes the overall analysis “quite sensitive to small changes in assumed” probability of success, Frazier said.

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Frazier found plenty of bones to pick with the profitability study, as well. The authors did not report return on equity, invested capital or assets, for example. “These measures are also important parameters for comparison, especially because many biopharmaceutical companies are research-intensive and funded by investors who deploy capital at fairly high risk over long periods of time and, consequently, demand higher returns,” Frazier said. That omission compounded the challenge of comparing pharma companies to the S&P 500, where companies from diverse industries might have “vastly different business models,” he wrote.  

Once you factor in the ongoing concerns about rising drug prices, you end up with a debate about the affordability of healthcare that “cuts across political parties at the federal, state, and community levels and is likely to intensify in the coming months,” Frazier warned in the JAMA editorial.

Frazier has long been concerned about the issues of drug affordability and biopharma profitability being politicized. Last fall, he said during a conference that the various plans being bandied about by U.S. presidential candidates to bring down drug prices could end up hampering innovation in the industry. He also noted that in a recent Gallup poll on consumer sentiment, pharma ended up on the bottom of a list of 25 industries, which is “not a good place to be,” he said.

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Harvard economics professor David Cutler, who served on the National Economic Council during the Clinton administration, also weighed in on the new JAMA studies with an editorial titled simply, “Are Pharmaceutical Companies Earning Too Much?”

Not necessarily, Cutler wrote. Given the industry’s high fixed costs, he argued, pharma companies have to charge above-cost rates. If a new policy were passed that pushed down the prices of all drugs, that would lower companies’ expected returns, deplete cash on hand and limit their ability to invest.

Just how JAMA’s package of studies on pharma profitability and pricing will influence the ongoing debate in Washington remains to be seen. But Frazier did see one data point he fears may be overlooked by zealous politicians seeking radical policies for reining in the drug industry. The study on drug pricing found that net prices did fall in the last three years that were tracked, and the paper on industry profitability reported that between 2014 and 2018, pharma company net incomes were “markedly lower” than they were in earlier years.

That’s a sign “the biopharmaceutical industry is adjusting its business model in response to concerns about affordable access to medicines and is still making substantial research and development investments,” Frazier contended.