Total Pharmaceutical Industry Returns

Another more indirect way to measure returns on R D is to estimate the profitability of research-intensive pharmaceutical companies. Pharmaceutical firms invest in the discovery, development, production, marketing and distribution of many products, including some that are not ethical pharmaceuticals, The total profit or return on a company s investment in a given period is a mixture of returns on past investments made over many previous years on many different projects. 

The annual financial reports of public companies contain estimates of company profit rates based on accounting records. For example, net income as a percent of total book value of assets is a commonly used benchmark of firm profitability (301). Companies themselves report 

It is not surprising, then, that analysts would compare the accounting profit rates of firms in the industry with those of firms in other industries (301,457). The ready availability of publicly reported and independently audited data and the widespread use of these measures by companies themselves invites such comparisons. By these conventional accounting measures, the pharmaceutical industry looks very profitable compared with other industries (301, 457). But these comparisons are limited in two important ways. 

accounting profits are poor measures of true IRRs. Revenues and costs recognized in accounting statements don t correspond very well to actual cash flows. And, because profits are computed over a limited period, they don t adjust properly for the time profile of cash flows from various investments made in previous times or for payoffs that won t occur until after the profit measurement period. 

Second, even if accounting profits are corrected to correspond more closely to IRRs, differences in rates of return among industries might reflect differences in their riskiness (and hence in the cost of capital). Simple comparisons that do not address differences in risk among industries can be misleading. 

---

This chapter summarizes trends in pharmaceutical research and development (R D) spending and compares estimates from available data sources. In short, the pharmaceutical industry invests more intensively in R D than do most industries, and expenditures in constant dollars have risen at an astonishing rate of roughly 10 percent per year. Since 1980, pharmaceutical firms in the United States and abroad have devoted an increasing proportion of total sales to R D. How much is spent What does this record of increasing real investment in R D say about the costs and returns to pharmaceutical R D, both in the past and in the future This chapter addresses these questions. 

---