Accounting 101 : Misrepresentation Of Pharmaceutical Profits

posted October 1, 2002

Earlier this year, Public Citizen, a national non-profit public interest organization founded by Ralph Nader, released a study claiming that the pharmaceutical industry was reaping huge profits in the midst of a downturn in the economy. A closer look at their calculations reveals a less dramatic story. [1] 

Basic Accounting and Extraordinary Items

At issue with Public Citizen’s calculations is the subject of extraordinary gains and losses.

Extraordinary items are both infrequent and unusual, arising as a result of "income (or losses) from events and transactions that are, as the name implies, extraordinary. A retailer might settle an expensive lawsuit, or sell a poorly performing mail-order operation. These items don’t happen every day or even every year, and so are separated from operating results." [2]  Many pharmaceutical companies enter other areas of business. If they purchase a cosmetics company, for instance, and then sell that company off at a later date, that sale is a one-time event that should have no bearing on continuing earnings.

Public Citizen obtained their data from the Fortune 500 list, which footnotes all extraordinary items for this reason. Public Citizen left those footnotes out of their report. By including extraordinary items in their calculations for pharmaceutical companies, the report they released significantly exaggerates the industry’s profits. Comparing the industry average for the top ten pharmaceutical companies’ profits can show the extent of this exaggeration. Including extraordinary items, the profit comes to 33.6 percent as opposed to 18.3 percent prior to their inclusion. 33.6 percent would reflect an 84 percent greater profit.

In fact, while the average profit for the top ten companies is 18.3 percent, some companies’ profits actually went down over the two-year period. Abbott’s profits, for instance, fell 44 percent and Schering-Plough’s fell by 20 percent. [3] 

Public Citizen’s use of a two-year period for its calculations fails to account for the certain aspects of the pharmaceutical industry. By its very nature, companies can reap large windfalls or great losses in any single year based on the success or failure of a particular drug. In addition, over short periods large spikes in profitability can develop as companies that have spent significant time in research and development release a successful drug. In addition, it is important to note the high level of competition in the industry. None of the leading 10 corporations by U.S. Sales in 2001 had more than a 10 percent market share. [4] 

Notes

[1] See "Pharmaceuticals Rank as Most Profitable Industry, Again," Public Citizen’s Congress Watch, April 17, 2002. Available at http://www.citizen.org/congress/reform/drug_industry/profits/articles.cfm?ID=7416.

[2] See Microsoft Money’s CNBC Investor Glossary, available at http://moneycentral.msn.com/investor/glossary/glossary.asp?TermID=165.

[3] All financial data obtained at Yahoo! Finance, available at http://finance.yahoo.com/?u.

[4] For more information, see http://www.imshealth.com/public/structure/dispcontent/1,2779,1343-1343-144068,00.html.