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Analysis of Manufacturing Costs in Pharmaceutical Companies

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J Pharm Innov (2008) 3:30–40
DOI 10.1007/s12247-008-9024-4
PERSPECTIVE
Analysis of Manufacturing Costs
in Pharmaceutical Companies
Prabir Basu & Girish Joglekar & Saket Rai &
Pradeep Suresh & John Vernon
Published online: 4 March 2008
# International Society for Pharmaceutical Engineering 2008
Abstract In the pharmaceutical industry, costs attributed
to manufacturing are a major part of a company’s total
expenses. In this paper, trends in various expense and
income categories of pharmaceutical companies have been
analyzed with particular emphasis on manufacturing costs
to gain an insight into their relationships and how they may
differ among types of pharmaceutical companies such as
brand name, generics, and biotechs. The study includes data
published in the annual reports of leading pharmaceutical
companies from 1994 to 2005. Twenty-two pharmaceutical
companies were selected based on the annual revenues. The
set was further divided into three groups: brand names,
generics, and biotechs. The analysis shows that, between
1994 and 2005, manufacturing costs (as a percentage of
total sales) are different for the three groups of companies
listed above. Additionally, each group of companies differs
in how savings are leveraged strategically. The data on
brand-name pharmaceutical companies also indicate that
there is a strong correlation between the reduction of the
cost of goods sold (COGS) and the increase in R&D
expenditure. This suggests the validity of Vernon’s theory
that for brand-name companies, a reduction in COGS will
P. Basu (*) : G. Joglekar : S. Rai
Pharmaceutical Technology and Education Center,
Purdue University,
W. Lafayette, IN 47907, USA
e-mail: prabir1960@purdue.edu
P. Suresh
School of Chemical Engineering, Purdue University,
W. Lafayette, IN 47907, USA
J. Vernon
Department of Finance, University of Connecticut,
Storrs, CT, USA
likely have a positive impact on investments in R&D,
presumably resulting in much needed innovations and
future health benefits for the society.
Keywords COGS . Pharmaceutical manufacturing
Background
Prescription drugs often provide effective alternatives to
expensive medical procedures and hospital stays. Conse-
quently, spending on prescription drugs as a percentage of
the total national health care spending is increasing. In
1999, prescription drugs accounted for 8.2% of the total
national health spending; that share was 11% in 2003 and is
expected to reach 14% by 2010 [1]. Although this is still a
relatively small proportion as a percentage of the total
national healthcare spending, it is one of the fastest growing
components of healthcare spending, increasing at double
digit rates from 1995 to 2003 [2].
The cost of bringing a new drug to the market place has
also been steadily increasing, with recent estimates project-
ing a required investment of over $2 billion to progress
from a laboratory idea to successful commercialization [3].
Pharmaceutical companies are spending more money on
R&D [4], while the productivity of their R&D investment,
computed as the number of drugs introduced to the market
place per year, is declining. Manufacturing costs are a
substantial part of their total cost structure [5]. According to
some estimates, these costs can be as high as 27–30% of
sales for manufacturers of brand-name pharmaceuticals
[1, 3], more than double the share of costs for research and
development [1]. No such estimates are currently available
in the literature for generic pharmaceuticals or drugs
manufactured by biotech companies.
J Pharm Innov (2008) 3:30–40 31

The manufacturing cost of pharmaceuticals, commonly generic, and biotech. The financial information for top
known as cost of goods sold (COGS), was approximately companies in each group, as disclosed in the annual reports
$90 billion in 2001 for the top 16 drug companies [1]. In published by publicly traded companies, was used in the
2008, it is estimated that (in absolute terms) the total COGS analysis. The main objective can be divided into the
for all pharmaceutical products could be as much as $200 following sub-objectives:
billion (estimated using 27% of estimated global pharma-
– Gain a better understanding of the trends in various
ceutical sales of $735 billion in 2008 [6]). In comparison,
expense and income categories within companies of
the total spending in absolute terms on R&D by the
each group.
Pharmaceutical Research and Manufacturers of America
– Study the trends of the overall expenses and revenues.
companies was $55 billion in 2007 [4].
Identify the differences in the trends, if any, of various
expense and income categories for each group of
Factors Affecting COGS of Pharmaceutical Companies
companies. If there are differences, identify the causes.
– Explore possible correlations between various expense
The pharmaceutical industry is strictly regulated due to its
and income categories and propose the cause of the
direct impact on consumer health and well being. To ensure
relationships.
that pharmaceutical products are safe and efficacious, the
Food and Drug Administration (FDA) periodically inspects
the facilities and procedures of all manufacturing operations
in the USA and those overseas operations that sell their Methodology
products in the USA. Consequently, these facilities and
procedures must be registered with the FDA and must The data used in this work were extracted from the annual
comply with the “(current) good manufacturing practices” reports of the pharmaceutical companies studied. The
(cGMP) established by the FDA. The high COGS of selected companies, based on annual revenues for the year
pharmaceutical products is the consequence, in part, of the 2005, are shown in Tables 1, 2, and 3. Brand-name
methods by which excellence in delivered product is pharmaceutical companies are the original developers of
achieved. Other factors contributing to the high COGS the drugs and have annual revenues of at least $10 billion.
and the potential for savings in COGS have been Generic pharmaceutical companies manufacture off-patent
summarized in a previous report [3]. drugs, with typical annual revenues of less than $5 billion.
To offset the effects of rising costs of commercialization, In 2008, more than two thirds of all prescriptions written in
shorter effective exclusivity periods, and diminishing the USA are expected to be for generics, and the generics
returns on R&D investment, manufacturing costs may be sales is expected to grow to more than $70 billion [6].
a source of savings for the pharmaceutical industry [3]. Biotech pharmaceutical companies are the original devel-
Reducing manufacturing costs without sacrificing quality opers of drugs made through biosynthetic processes. Brand-
could be a way to effect social good in an environment name companies account for the greatest share of the
where more and more investment is required to find new market, though the weighted coverage of all companies is
therapies for unmet medical needs along with a need to well over 50% of the total market.
control or slow down the rate of price increases of
prescription drugs. In fact, there are important linkages
between the efficiency of pharmaceutical manufacturing, Table 1 Sample US brand-name pharmaceutical data set
drug prices, and public health in the USA [7]. It can be Company % Total market share
predicted that reductions in manufacturing costs will lead to
gains in consumer surplus (the difference between con- Pfizer Inc. 8.5
sumers’ willingness to pay and what consumers actually Johnson & Johnson Inc. 8.4
GlaxoSmithKline PLC 6.3
pay; the standard economic measure of social welfare)
Sanofi-Aventis 5.4
worth trillions of dollars. Novartis 5.4
Astra Zeneca PLC 4.0
Abbott Laboratories 3.7
Objectives Merck & Co. Inc. 3.7
Bristol-Myers Squibb 3.2
The main objective of this study was to assess and analyze Wyeth 3.1
manufacturing costs of pharmaceutical products across Eli Lilly & Co. 2.4
Schering-Plough Corp. 1.6
important industry categories. The companies comprising
55.6
this sector were divided into three groups: brand name,
32
Table 2 Sample US generic pharmaceutical data set
Company % Generics market share
Teva 9.5
Ivax* (2004) 3.3
Watson 3.0
Mylan 2.3
Barr 1.9
Alpharma 1.0
Par 0.8
21.9
Financial Information
The financial information about the companies was
extracted from the Wharton Research Data Services
(WRDS) Compustat [8] database. The data for the
following revenue and expense categories were extracted:
(a) Sales (SALES)—aggregate sales of a company’s
complete product offering.
(b) Cost of goods sold (COGS)—also referred to as
materials and production cost. Cost of goods sold is
an aggregate figure that includes all costs incurred in
producing the goods including write-offs from plant,
property and equipment, raw materials, inventory, etc.
(c) Research and development expense (R&D)—research
and development expenses that are separate from the
cost of goods sold.
(d) Selling, general, and administrative expense (XSGA)—
these expenses provide for sales, marketing, as well as
general expenses incurred by the product pipeline.
XSGA provided by the WRDS database includes
salaries, rent, and research and development (R&D)
cost. In this study, R&D and general expense were
treated as separate categories.
(e) General expense = XSGA − R&D.
(f) Taxes—taxes paid by the company.
(g) Depreciation—the steady loss in the value of capital
goods over a specified time period.
(h) Operating income (after depreciation and taxes)—
profits after depreciation and taxes; these are company
earnings from core operations after deducting the cost
of goods sold, and selling and general operating
expenses.
Operating income ¼ Sales
COGS
XSGA

Depreciation
Taxes
For the categories given above, data were extracted for a
span of 12 years, from 1994 to 2005.
J Pharm Innov (2008) 3:30–40
Data Collection and Analysis
To compare data in various categories across the three
company groups, the extracted data were normalized with
respect to the annual sales for the corresponding year
(represented as COGS%, general expense, etc.). The
normalized data were used for the detailed analysis.
Assumptions and Limitations
The authors have assumed that the data reported by the
companies in the financial statements are based on the same
interpretation of various categories. For example, COGS
should be truly inclusive of all costs pertaining to drug
manufacturing only. Although all companies follow gener-
ally accepted accounting practices, it is difficult to enforce
and monitor uniformity in their interpretations. One of the
limitations of the information obtained from financial
statements pertains to the lack of itemized information by
product, that is, we cannot associate a certain cost to a
certain product or process. From financial statements alone,
we cannot determine a firm’s unique or competitive
advantage in manufacturing capabilities. Also, some com-
panies are, in reality, large conglomerates reporting all
business units, including non-pharmaceutical operations,
under one single filing.
For our analysis, we have chosen a sample space of
companies. Although these companies account for a major
share of the market, a significant number of companies
have not been included in the study.
The following procedures were applied to study the
aggregate data for each group of companies, namely, brand
names, generics, and biotechs:
– Polynomial or linear trend lines were fitted to the data
set and general trends were observed.
– The significance of change in each category was
established by using a t test, which assesses whether
the means of two groups are statistically different from
each other. Relationships were proposed among the
Table 3 Sample US biotech pharmaceutical data set
Company % Total share
Amgen Inc. 24
Genentech Inc. 13
Genzyme Corp. 5
Biogen Idec Inc. 5
46
J Pharm Innov (2008) 3:30–40 33

Brand Name (with merck)

COGS% Generics
was analyzed. The variations over the years for different
Biotech groups of companies were plotted, and the corresponding
Brandname Avg. (26%)
Generics Avg. (52%) averages were compared with Reinhardt’s average. Figure 1
70% Biotech Avg. (14%)
60% Reinhardts Avg. (27%) shows the trends in the COGS% data for brand name,
50%
generics, and biotechs, along with their corresponding
COGS %

40%
arithmetic averages. The average COGS% for brand-name
30%
companies is nearly equal to the average estimated by
20% Reinhardt. However, the average COGS as a percentage of
10% sales, is almost half the arithmetic average for COGS as a
0% percentage of sales for generics and roughly double that of
1994 1996 1998 2000 2002 2004 2006 biotechs. The higher value of COGS as a percentage of
Year
sales for generics is possibly a reflection of lower
Fig. 1 COGS% for different types of companies
expenditure on R&D and sales, and marketing for the
generic industry. However, it is also quite revealing to
realize that the COGS% is significantly lower for biotechs.
The COGS as a percentage of total sales (COGS%) for
factors that showed significant changes and trends. The
brand names appears to have declined during the years
significance level was chosen to be 0.05 (alpha value).
2000 to 2005. On the other hand, the COGS% for generics
The period under consideration was divided into two
increased until the year 1996, and since then, there appears
sub-periods of 6 years each. The arithmetic averages of
to be a gradual decline. The COGS% values of generics
various expenses and incomes were calculated for each
show a gradual reduction over the last 8 years. Biotechs
sub-period. A t test was then done to find the
show more fluctuations than either generics or brand-name
significance of the change from one sub-period to
companies.
another.
As a special case, the time series data for Schering-
– The relationships were quantified by computing the
Plough are shown in Fig. 2. In the case of Schering-Plough,
correlations among different factors.
COGS% was significantly lower than the industry average
– For the factors that showed significant changes, the
until about 2001. However, it increased significantly over
corresponding averages were compared with Reinhardt’s
the years 2002–2004, growing more than the industry
average from financial data collected for eight brand-
average and then appears to have dropped back to the level
name companies in 1998 [1]. To provide an economic
of the industry average. Correspondingly, the operating
perspective on the pharmaceutical industry, Reinhardt
income, which was slightly above the overall industry
cites a Deutsche Banc Alex Brown research report and a
average, dropped sharply over the years 2002–2004 and
Banc of America Securities LLC report that shows
then showed an increasing trend in 2005. The possible
breakdowns of the disposition of the sales revenue
explanation for this is that Schering-Plough entered a
earned by the largest research-based pharmaceutical
consent decree with the FDA in 2002, agreeing to
manufacturers (defined as brand-name companies in this
paper) in 1988. Reinhardt also urges caution in
interpreting the data and provides some of the reasons
for that. Similar caution must be exercised in interpret-
ing the financial data reported in this study. Schering-Plough
COGS% Brand-Name
35% OIADP&T%
30% R&D%
Key Observations
25%
20%
Trends Analysis COGS%, R&D%, Operating Income, 15%
and General 10%
5%

COGS 0%
1994 1996 1998 2000 2002 2004 2006
-5%
-10%
The trend of COGS, R&D, operating income, and general
-15%
expense as a percentage of total sales for the different types Year
of pharmaceutical companies over a 12-year time period Fig. 2 Schering Plough Corporation time series plot
34
Brand name
R&D% Generics
Biotech (without year 2002)
Brand name Avg. (13%)
40%
Generics Avg. (8%)
35% Biotech Avg. (26 %)
Reinhardt's Avg.( 13%)
30%
25%
R&D%
20%
15%
10%
5%
0%
1994 1996 1998 2000 2002 2004 2006
Year
Fig. 3 R&D for different groups of companies (without 2002 data for
biotechs)
revalidate the manufacturing processes at several sites in
the USA and Puerto Rico, resulting in significant increase
in COGS% since 2002. In addition, it discontinued certain
older profitable products and outsourced other products.
The fact that, until 2002, the COGS% at Schering-Plough
was significantly lower than the industry average for brand-
name companies could be reflecting a lower investment in
plant, equipment, and cGMP systems, which could have
resulted in the findings of cGMP deficiencies.
R&D
The trends in R&D expenditures as a percentage of sales
(R&D%) are shown in Fig. 3. The data point for 2002 was
removed for biotechs, which is considered as an outlier.
The R&D% for brand-name companies appears to be
gradually increasing over the past few years. The average
value is very close to Reinhardt’s average. The trend for the
generics is substantially flat with peaks in 2000 and 2004.
The average value is slightly greater than half of the
average estimated by Reinhardt and the brand-name
industry average. This is expected since most generics are
not expected to devote resources to discovering new drugs.
As a result, their R&D% expenditures are largely directed
to developing marketable formulations of a large number of
drugs that are either out of patent or may be soon. The trend
for biotechs shows a record high R&D expenditure in the
year 1996 when it reached nearly 32%. Since 1996, the
R&D% has been fluctuating with an overall decreasing
trend. For biotechs, the average R&D expenditure as a
percentage of sales is twice Reinhardt’s average for brand-
name pharmaceuticals. Biotechs heavily invest in R&D to
discover new therapies; their R&D success rates are lower,
and they have a smaller portfolio of marketed products.
J Pharm Innov (2008) 3:30–40
Operating Income
The trend in operating income as a percentage of sales is
shown in Fig. 4. The average operating income for brand-
name companies is around 19%. There is a gradual increase
in its value until the year 2003. After that, the trend
indicates a gradual decrease. However, the slope is very
small, and no definitive conclusions can be drawn. The
yearly average for generics is around 12%, which is lower
than that of brand-name and biotechs. The operating
income data for generics show a significant dip in 1997,
and after that, the trend indicates that it has been gradually
increasing. However, there is more fluctuation in the data
for generics as compared to that for brand-name companies.
For biotechs, the total number of companies in the data set
is small. However, there appears to be an increasing trend
of operating income in recent years.
General Expense
The trend in general expenses as a percentage of sales is
shown in Fig. 5. The trend for brand-name companies is
flat, and the average value is slightly less than the average
reported by Reinhardt in 2001. The trend for generics
shows more fluctuations compared to the brand-name
companies, with the lowest value being 12% in the year
2004. The average value of general expenses for generics is
nearly half of Reinhardt’s average, which confirms that the
generics spend less money in marketing and sales than
brand names or biotechs. The average value of general
expense for biotechs is slightly higher that that of generics
but lower than that of brand-name companies. Biotech
drugs are unique, have less competition from similar (me-
too) drugs in the market, and treat specific unmet needs.
Therefore, the biotechs may not require as much marketing
and sales effort as do brand-name companies. The trend for
Brand name
Generics
0.4 Biotech
Brand name Avg. (19%)
Generics Avg. (12%)
Operating Income/Sales
0.3 Biotech Avg. (22%)
0.2
0.1
0
1994 1996 1998 2000 2002 2004 2006
Year
Fig. 4 Operating income for different types of companies
J Pharm Innov (2008) 3:30–40
Fig. 5 General expense for
different types of
companies
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
1994
biotechs, however, shows more fluctuations than brand-
names as well as generics.
Relationship Between COGS, R&D, Operating Income,
and General Expense
The data were used to study the relationships between
COGS, R&D, operating income and general expense. Only
the following strong correlations were found from the data:
COGS and R&D for brand name, and COGS and operating
income for generics. The results are discussed in this section.
Brand-name Companies
The link between manufacturing costs, price of drugs, and
profits, etc. has recently attracted much attention [1, 7]. In
spite of the recent work by Vernon [7], the question is often
raised whether savings resulting from improvements in
manufacturing efficiencies would have any impact on
pharmaceutical prices or investment in R&D for discovery
of new drugs, or instead, would they merely increase the
profits of these pharmaceutical companies. This question
may in fact have been the main obstacle to public funding
of research that would result in reduction of COGS for
pharmaceutical companies. Although an in-depth answer to
such questions is beyond the scope of this paper, we
explore here the historical quantitative link between
manufacturing costs, profits, R&D, and general expenses.
Vernon [7] discusses two scenarios in which the various
expenses and incomes are related to each other. In scenario
1, Vernon has proposed that, by lowering the COGS
through improvement in manufacturing efficiency of
pharmaceutical companies, the market price for pharma-
ceutical products will decrease with all the other costs kept
constant. This will lead to gains in consumer surplus [7]. In
35
General Expense
Brand-name
Generics
Biotech
Brand-name Avg. (31%)
Generic Avg. (18%)
Biotech Avg. (21%)
Reinhardt's Avg. (35%)
1996 1998 2000 2002 2004 2006
Year
scenario 2, the market price is not lowered, and the
decrease in COGS, as a result of improved manufacturing
efficiency, will positively impact R&D spending of phar-
maceutical companies, which will also eventually benefit
the consumers. This implies that if COGS can be reduced,
the pharmaceutical companies will invest those savings into
discovery of new therapies for unmet medical needs. In
fact, Vernon’s economic model calculates that the overall
gain in consumer surplus is higher in scenario 2 than in
scenario 1. Vernon also suggests that the actual effect of
improving manufacturing efficiency possibly exists be-
tween the above two scenarios.
Trend lines (linear or polynomial), fitted to the raw data
set using the standard function of Microsoft Excel, show
that there are significant changes in COGS%, operating
income, general expenses, and R&D% (Appendix 2
Fig. 13) for brand-name companies. The COGS% data
exhibit a decreasing trend, while the R&D% data exhibit
an increasing trend over the time period used in the study
(1994 to 2005). The operating income and general
expenses, however, show rising and falling trends,
respectively, with small gradients. Other expenses, such
as taxes and depreciation, show a flat profile.
The t test performed on the data, shown in Appendix 2
Table 4, supports the observation that, between the two sub-
periods of 1994 to 1999 and 2000 to 2006, there is a
significant decrease in the average COGS% and general
expenses, a significant increase in the average R&D% and
operating income, and no significant change in the average
values of taxes and depreciation.
The correlation between COGS% and R&D% was found
to be −0.93, showing a strong negative correlation between
the two. Figure 6 shows the trends in COGS% and R&D%
over the years. The fitted equations along with the data
points are also provided along with the R2 values, which
36 J Pharm Innov (2008) 3:30–40

% of sales Biotechs
18%

16% y = -0.6038x + 0.2852 Appendix 2 Fig. 15 shows the variation in different

R2 = 0.8645
expenses over the studied period for biotechs.. The 2002
14%
data for general expenses and R&D% showed unusually
R&D

12%
10%
8%
6%
19% 21% 23% 25% 27%
COGS
Fig. 6 Relationship between COGS and R&D—brand names
indicate the goodness of the fit. A decreasing trend for
COGS% and increasing trend for R&D% can be observed.
Thus, the strong correlation along with the trends supports
Vernon’s scenario 2 that, during the recent past, for brand-
name companies, savings in COGS has positively impacted
investments in R&D, resulting in much-needed innovations
and future societal health benefits.
Trend lines for brand name companies
Fitted line
COGS% y ¼
0:0013x þ 0:0071x þ 0:276
2 0.75
R&D% y ¼ 0:0004x2 þ 0:0004x þ 0:1067
Generic Companies
Similar trend lines were also fitted to the data set over the
studied period (1994–2005) for generics. A decreasing
trend was observed for COGS% and general expenses,
while a rising trend was observed in operating income. The
trend for R&D% shows almost a flat profile. The
observations in trends were also supported by t test as
shown in Appendix 2 Table 5, where significant changes
were only observed in COGS%, general expenses, and
operating income. During the period under study, for
generics, the COGS% and general expenses decreased,
while operating income increased.
The correlation between COGS% and operating income
was found to be −0.92, showing a strong negative
high deviations due to the data from AMGEN and hence
were considered as outliers and removed for further
analysis (Fig. 10). Trend lines were fitted to the reduced
data. There is large fluctuation in the data, and the trend
lines do not fit well with the data points. A t test was done
29% 31% to find the significance of changes in the various factors, as
shown in Appendix 2 Table 6. Only depreciation increases
significantly over the years. Thus, the analysis suggests that
for biotechs, all the expense categories such as COGS%
and R&D% have remained almost constant, other than
depreciation which has increased for the period studied.
General Observations
Aside from the key observations given above, the following
are some general observations based on analysis of the data:
R2 – The total sales of the brand names were about 90%
of the total sales of all the companies in this study;
0.81 thus, the performance of the brand names has a
significant impact on the total market. This is in line
with the IMS global pharmaceutical market forecast
[6]. Therefore, an economic model, such as the one by
Vernon for the brand names, will be a good predictor of
the overall pharmaceutical market behavior.
– For generics, the manufacturing expense is nearly 50%
of the total sales revenues as compared to about 27%
for that for brand names. It was surprising to note that
the COGS% for biotechs was the lowest.
– Among all the three categories of pharmaceutical
companies, for biotechs, the expenditure on R&D%
as a percentage of sales is the highest. The biotechs
appear to invest the most in R&D with an average
% of sales
25%

correlation between the two observed in Fig. 7. From the y = -1.0304x + 0.6597
20%
figure, it can be observed that the COGS% showed a R2 = 0.8528
Operating Income

decreasing trend, and operating income showed an increas- 15%

ing trend over the years. Therefore, for generics, it appears
that the reductions in COGS% may be contributing to 10%

increase in operating income.

5%
Trend lines for generics
Fitted line R2 0%
COGS% y ¼
0:0005x þ 0:0038x þ 0:5616
2 0.63 40% 45% 50% 55% 60% 65%

R&D% y ¼ 0:0009x2 þ 0:0002x þ 0:0871 0.59 COGS

Fig. 7 Relation between COGS and operating income for generics
J Pharm Innov (2008) 3:30–40 37

COGS%
R&D% of 27. As expected, R&D% for generics is the Merck and Co.
General Expenses
smallest, nearly one third that of biotechs. Operating Income
– Operating incomes for brand names and biotechs are 70%
R&D%
60%
nearly equal and higher than those for generics.
50%

% of sales
– The general expense for brand names is nearly equal to
40%
the industry average reported by Reinhardt in 2001 and 30%
is much higher than those for generics and biotechs. 20%
10%
0%
1992 1994 1996 1998 2000 2002 2004 2006
Conclusions Year
Fig. 8 COGS%, general expenses, operating income, and R&D% for
The following conclusions can be drawn from the study: Merck and Co.

– As expected, it appears that a significant difference in
how the three different categories of pharmaceutical
companies, viz. brand names, generics, and biotechs,
spend their revenues.
– For brand names, COGS per unit sales showed a significant
decrease, while R&D per unit sales displayed a significant
increase during 1994 to 2005. Moreover, COGS% was
found to be negatively correlated with R&D% across time,
suggesting that the cost savings associated with a reduced
COGS may have been budgeted for increased expenditure
on research and development for the discovery of new
therapies, as predicted by Vernon [7]. This work did not
consider alternative hypotheses for increased R&D expen-
ditures during the period studied.
– For generics, COGS% showed a significant decrease,
while operating income showed a significant increase
over the years. COGS% was found to be strongly
negatively correlated to operating income. Generics are
not involved in the discovery of new therapies, so their
R&D expenditure is likely more geared toward devel-
oping formulations of already approved drugs whose
patents are about to expire. Thus, for generics, the
savings from COGS is probably not invested in
research and appears to result in increased profits.
– For biotechs, most of the factors studied do not show a
significant change over the years except for depreciation.
Fluctuations were found in the data compared to brand
names and generics, but the data failed to show any trend.
Interestingly, depreciation is significant for these compa-
nies, which might be an effect of the high capital
investment required to manufacture biotech products.
from 1994 to 2002 but dropped sharply to 15% in 2003 and
stayed close to that value for the next 2 years. Also, the
value of 15% in the past 3 years is significantly different
from the industry average. General expenses, operating
income, and R&D% showed an increase after 2002.
Although no explanation has yet been provided for the
sharp changes in the trends for Merck, the following factors
may have contributed these deviations. In 2001, the
divestiture of Medco Health Solutions (MHS) from Merck
and Co. was completed. The COGS% data for MHS is
shown in Fig. 9. As MHS is primarily focused on
distribution of drugs, the most important part of its
expenses is COGS (more than 90%). Therefore, before the
divestiture Merck’s COGS% was significantly higher than
the industry average and after the divestiture, it reduced
significantly. However, that does not explain why the COGS
% was reduced below the industry average after 2002.
In 2004, Merck withdrew Vioxx from the market due to
the revelation of potentially life-threatening side effects. It is
also possible that, because of Vioxx withdrawal, the company
may have made certain decisions to safeguard against large
litigation costs. We expect that, over an extended period, the
various expenses will stabilize to industrial averages.
Figure 10 shows the R&D% and general expense for
biotechs. There is a sudden rise in the R&D% and dip in
general expenses in the year 2002 due to high R&D%
120%
Medco +Merck
100% Medco
Merck
80%
COGS%

60%

40%
Appendix
20%

Appendix 1: Anomalies in the Data 0%

1992 1994 1996 1998 2000 2002 2004 2006
The data for various categories for Merck & Co. are shown Year
in Fig. 8. The COGS% increased steadily from 36% to 60% Fig. 9 COGS% trend
38 J Pharm Innov (2008) 3:30–40

Biotech
IVAX Corporation COGS%
R&D%
60% Operating Income
General Expenses
100%
50%
R&D
40% 80%
% of Sales

30% 60%
20%
40%

% of sales
10%

0% 20%

-10%1992 1994 1996 1998 2000 2002 2004 2006

0%
Year
1994 1996 1998 2000 2002 2004
-20%
Fig. 10 R&D and general expense per unit sales for biotechs
-40%

expenses from Amgen Inc. We have not uncovered any -60%

explanation for this variation. This data point was consid- Year
ered as an outlier and excluded from the calculation of the
Par Pharmaceuticals
overall R&D% and general expenses for biotechs. COGS%
As shown by the time series data in Fig. 11, Bristol 100% Operating Income
Meyers Squibb also experienced a similar setback in 2001, R&D
80%
resulting in higher manufacturing costs in that year. This
60%
anomaly was apparently due to accelerated depreciation,
asset impairment, and restructuring expenses, as explained % of sales
40%

in the 2004 annual report. 20%

0%
The 1996–1997 Effect 1994 1996 1998 2000 2002 2004 2006
-20%

-40%
An anomaly was observed for some of the generics during Year
the years 1996 and 1997 (Fig. 12). In this period, these
companies had sharp increase in COGS% and a corre- COGS%
Mylan Laboratories Inc
sponding decrease in operating income. Operating Income
The plots show a dramatic change in COGS% and R&D
60%
earnings in 1996–1997. Some companies have provided
50%
explanations in their annual reports. For example, IVAX
% of sales

40%
Corporation has provided the following explanation:.
“During 1996, certain national drug wholesalers instituted 30%

programs designed to provide cost savings to independent 20%

retail pharmacies on their purchases of certain Generic 10%

pharmaceutical products. Pursuant to the programs, inde- 0%

1994 1996 1998 2000 2002 2004 2006
pendent retail pharmacies generally agreed to purchase their
Year
Fig. 12 1996–1997 effect for three generics, IVAX Corporation, Par
Bristol-Meyers Squibb Pharmaceuticals, and Mylan Laboratories
COGS%
50% General Expenses requirements of Generic pharmaceutical products from one
Operating Income
wholesaler and permitted the wholesaler to select the
40% R&D%
product suppliers. Each wholesaler encouraged Generic
drug suppliers to participate in its program by offering to
% of sales

30%
purchase the wholesaler’s requirements of particular prod-
20% ucts from a single supplier. The programs encouraged
Generic drug suppliers to aggressively bid to be the
10% exclusive supplier of products under the programs. The
existence of the programs also resulted in reduced prices to
0%
1994 1996 1998 2000 2002 2004 2006 non-wholesaler customers. As a result, the Generic drug
Year industry experienced a significant reduction in the prices
Fig. 11 Bristol Meyers Squibb time series plot charged by suppliers for many of its products during the
J Pharm Innov (2008) 3:30–40 39

Depreciation %
second and third quarters of 1996. Other wholesalers have
commenced or are expected to implement similar programs,

0.15001
and such programs may be expanded to other product lines

4.0%
4.9%
0.8%
and customer groups. Also during 1996, the Company
experienced increased competition some of its more
important domestic Generic pharmaceutical products as a
result of product approvals obtained by competitors.”
Although not explicitly stated, this explanation may be

0.20516
applicable to all generic drug manufacturers.

6.6%
6.3%
−0.3%
Taxes
For IVAX, the increase in COGS is also marked by a
restructuring program, which may explain the gradual

Table 4 The t test for the variation of the different costs as a percentage of sales between two sub-periods (1994–1999 and 2000–2005) for brand names
decrease in COGS over the following years. Although the
above summaries appear to be reflective of what has
occurred, a compelling explanation backed by numerical
analysis is yet to be seen.

General expense
Appendix 2: Trend Analysis

0.18072
31.9%
30.7%
−1.2%
COGS%
Brand Name companies Operating Income
R&D%
General Expenses
Taxes
Deprec%
Poly. (General Expenses)
40% Poly. (COGS%)
Linear (Operating Income)
35% Poly. (R & D %)

Operating income
30%
% of sales

25%

0.034339
20%
17.9%
19.4%
1.5%
15%

10%

5%

0%
1994 1999 2004
Year
0.00381
R&D %

14.3%

Fig. 13 Trend analysis for various expenses and incomes for brand-
3.1%
11.2%

name companies

COGS
Generics companies
General Expenses

Operating Income
0.03573
COGS%

R&D
28.1%
24.2%
−3.8%

DEPREC
60%
TXT
50%
% of sales

40%

30%
Average (II, 2000–2005)
Average (I, 1994–1999)

20%

10%
Probability (p)
Change (II−I)

0%
1994 1996 1998 2000 2002 2004 2006
Year
Fig. 14 Trend analysis for various expenses and incomes for generics
40 J Pharm Innov (2008) 3:30–40

Table 5 The t test for the variation of the different costs as a percentage of sales between two sub-periods (1994–1999 and 2000–2005) for
generics

COGS% R&D% Operating income General expense Taxes Depreciation %

Average (I, 1994–1999) 55% 7% 9% 20% 5% 4%

Average (II, 2000–2005) 49% 8% 15% 17% 6% 4%
Change (II−I) −5% 2% 6% −4% 1% 0%
Probability (p) 0.013304 0.215482 0.0078548 0.011321 0.3284274 0.56438

COGS%
Biotech companies General Expenses
Taxes
Depre%
Operating Income
R&D%
Poly. (R & D %)
Linear (General Expenses)
Poly. (Operating Income)
40% Linear (COGS%)
Linear (Taxes)
35% Linear (Depre%)
30%
% of sales

25%
20%
15%
10%
5%
0%
1994 1996 1998 2000 2002 2004 2006
Year
Fig. 15 Trend analysis for various expenses and incomes for biotechs

Table 6 The t test for the variation of the different costs as a percentage of sales between two sub-periods (1994–1999 and 2000–2005) for
biotechs

COGS% R&D% Operating income General expense Taxes Depreciation %

Average (I, 1994–1999) 13% 28% 23% 21% 9% 6%

Average (II, 2000–2005) 14% 24% 21% 26% 9% 9%
Change (II−I) 1% −3% −2% 5% 0% 3%
Probability (p) 0.716411 0.097504 0.0718329 0.3020194 0.734358 0.005236

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