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The Price of Profits

Pharma: an industry shaped by shareholder value

Dan Bobkoff Jun 15, 2016
Big Pharma has remade their business models over time to maximize shareholder value.  Joe Raedle/Getty Images
The Price of Profits

Pharma: an industry shaped by shareholder value

Dan Bobkoff Jun 15, 2016
Big Pharma has remade their business models over time to maximize shareholder value.  Joe Raedle/Getty Images

There’s a new way of doing business for much of Big Pharma. 

Instead of relying on their own expensive laboratories, they also buy drugs or their makers and focus on getting treatments through the Food and Drug Administration and onto your TV screens. Then, raise prices every year. Move overseas for tax advantages. And reward shareholders by buying back billions’ worth of shares.

It wasn’t always like that. 

“George Merck summed it up — one of the original CEOs of Merck back in the ’50s — that the mission of Merck and other pharmaceutical companies at the time was to take care of patients and profits would follow,” said Joel Hay, a professor of pharmaceutical economics and policy at the University of Southern California.

At Merck & Co., in the middle of the 20th century, the idea that patients came before profits “was a big part of our culture,” said Scott Lucas, who worked in sales at the company for more than 30 years, starting in the 1970s. 

Lucas and other workers describe an era of the highest ethical and moral standards. Drug trials were halted over the most tenuous rumor that a similar drug in development by a competitor was running into issues. Sales staff took pains to educate doctors about the downsides of Merck’s treatments. 

In the second half of the 20th century, Merck really was a company where shareholder value was the result, not a prime motivation.

It ran huge, productive research labs full of top-notch scientists. In charge of those labs was Roy Vagelos, who went from chief scientist to become CEO in 1984.

“My interest was never making money,” Vagelos, 86, said in an interview with Business Insider and Marketplace. “Even as CEO. Especially as CEO.”

By today’s standards of management, it’s as if Vagelos did everything wrong. 

‘We’re leaving money on the table’

He refused to raise drug prices more than inflation. When he told that to Merck’s marketing team, Vagelos said, “They said, ‘We’re leaving money on the table,’ of course. And I said, ‘Fine, that’s what we’ll do.’” 

He bailed out of business school after just a week, which is maybe why he didn’t think much about Wall Street. 

“I never worried about stockholders ever. It never crossed my mind. I even refused to meet with stock analysts.” 

At one point, he made a last-minute decision to donate a massive quantity of a drug that cured river blindness in patients in Africa. It cost the company a lot of money. 

“One of the people — when I was reporting it — at the next board meeting said, ‘You never called us!’ And I said it was going so fast, it never crossed my mind. I forgot about it.” 

You could be cynical about this. You could argue holding down drug prices helped stave off regulations, and there were a lot of public relations benefits to that donation in Africa. 

But by not focusing on maximizing shareholder value, Merck did really well. During Vagelos’ era, it came out with lots of new drugs, which led Merck’s stock price to increase an average of 22 percent per year. In the years since, it has been just 5 percent a year. 

But these days, it’s just about impossible to run a company the way Vagelos ran Merck. 

“You have to provide a little bit of something for everybody,” said Brent Saunders, the CEO of Allergan. You might know it as the maker of Botox. Allergan is highly respected by Wall Street and its competitors, but Saunders can’t ignore investors. 

“You need to have good short-term performance,” he said in an interview with Business Insider and Marketplace. “You have to have sound midterm strategy and performance, and ultimately, because of the product cycle and the way we innovate over the long term, really have conviction around your long-term strategy. I try to do it all.” 

Here are some of the ways Allergan is a model of a modern pharmaceutical company, with its research, price and tax strategies:

Allergan more often acquires drugs or companies rather than go through the risky process of discovering and developing drugs from scratch, as companies like Merck did in their heyday. 

A good portion of its R&D pipeline is dedicated to finding new purposes for existing drugs like Botox, which currently has 11 approved uses and more on the way. So far it can be used for wrinkles, migraines, overactive bladders and more. 

‘It’s like milking a cow’

“Their success is really based on a drug that seems to be just like the market opportunities are endless,” said Oner Tulum, a researcher at the University of Massachusetts Lowell. “It’s like milking a cow.” 

Saunders calls Botox “a pipeline in a product.” 

And Saunders can’t ignore his share price, especially now that he has one of the most famous activist investors taking a big stake in Allergan: Carl Icahn. 

“I view Carl as just one of many important shareholders,” Saunders said. “We listen to all of our shareholders, activist and passive, and long term and short term.” 

Icahn is leaving Saunders alone for now, but that could change. He has a history of pressuring companies to make moves and then getting out of the stock.

To save on taxes, Allergan is technically an Irish company, even though Saunders mostly works in New Jersey. It caused a little tension between Saunders and his father when Pfizer tried to buy Allergan to take advantage of the tax deal. 

“I was arguing that taxes aren’t a question of patriotism,” Saunders said. “He kept insisting, and ultimately I said he had moved to Florida because it had zero state income tax and zero estate tax, and I said, ‘Look, you did a personal inversion.’” 

Saunders said that being based in Ireland allows Allergan to use the savings to invest more in the U.S.

Then, there’s price: Allergan said it raises prices roughly 8 percent a year — far greater than inflation, but also nothing like a Valeant.

But for all the ways Allergan is an example of the new way pharmaceutical companies operate today, Saunders sometimes sounds a bit like Vagelos. 

“When we do well for patients, when we come up with innovation for an unmet need, when we can improve a patient’s life by one of our treatments, our shareholders benefit,” he said. 

Today, Merck and other Big Pharma companies look more like Allergan. Their own research teams haven’t been so productive lately, so they increasingly buy up drugs and their makers. 

The old established companies are spending billions buying back their own shares.

After Vagelos retired from Merck, he made a fortune as chairman of the biotech firm Regeneron. What does he think of newer firms and their business models? 

“Well, I don’t think much of them,” he said. “The bio/pharmaceutical business is different from selling buttons and bicycles.” 

Wall Street, though, might not agree. 

“The Price of Profits,” our series with Business Insider, looks at what happens when profits become a company’s product. For more, visit priceofprofits.org.

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