Pharmaceutical company shareholders watching 60 Minutes on CBS last night got a preview of the looming political debate on drug costs. Was the criticism just? Let's look at the facts.
Here's what 60 Minutes had to say: "It may come as no surprise that the pharmaceutical industry is the most profitable business in the country." Oh? The computer software industry enjoys gross margins of 65%. Pharmaceuticals clock in at 60%. Interesting.
Microsoft's (Nasdaq: MSFT) gross margins of 82% and net income of $8.8 billion are certainly higher than those of pharmaceutical giants Pfizer (NYSE: PFE), Merck (NYSE: MRK), and GlaxoSmithKline (NYSE: GSK). Perhaps, they meant to say that the $300 billion pharmaceutical industry produces more profits than the $150 billion computer software industry.
Sort of like comparing apples to oranges, wouldn't you say? Words, like drugs, are best used carefully.
But 60 Minutes was much closer on the real issue: pricing. For proof, go online to Walgreen (NYSE: WAG) or J.C. Penney's (NYSE: JCP) subsidiary Eckerd's websites and type in the world's top-selling prescription drug, Lipitor. The drug costs 40% more on either site than it does at MyDrugs Canada.
But don't blame a greedy American corporate culture. Even overseas companies are selling drugs for higher prices in the U.S. Swiss-based Novartis' (NYSE: NVS) Diovan HCT160 is much cheaper in Canada. Drug prices in general, regardless of a company's country of registry, are higher in the U.S.
Sadly, however, the thrust of the 60 Minutes story is this: "The United States is the only industrialized country without some form of control on the prices of drugs. The U.S. also accounts for more than half of the industry's profits." In other words, the way to reduce health costs (the real issue) is government control.
The reason we pay such high prices for drugs is -- like the solution -- is not entirely clear. True, there are high costs for R&D and relatively short lives on patents. But that is true around the world. The cost of court settlements in the U.S. is certainly an issue. We're all tired of watching drug commercials on TV -- especially the ones that don't mention the purpose of the drug ("to get back in the game?"). That has to be a waste of money.
Still, while it offers little by way of solutions, the 60 Minutes story does help investors see how the upcoming debate on drug prices might be framed. Prescription drugs make for an extremely profitable business. Pricing in the U.S. is much higher than elsewhere. The profitability of prescription drugs could be headed lower -- maybe much lower.
Right or wrong, if you want to invest in this industry, or if you are evaluating your current investments, there is a new risk in town -- U.S. price controls. The side effects from drug legislation are unknown, but they could, indeed, be hazardous to your financial health.
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