Oh, and if you haven't read Mike Hendrix's explanation of the realities of driving near big rigs, you should. Right now. I worry about you guys, you know. Safety first.
Jessica's rant on hyperstylism is causing me to drag out one of my pet theories, which applies to the current crop of modern novelists thus: almost none of these folks will be remembered in 100 years.
Why? They're all hat and no cattle, a long run for a short slide. There's no there there. They're all politics and prose, no plot or character. And that may sell to people in English departments who read enough literature to get bored with compelling characters and deft plotting, but in fifty or a hundred years, no one except those confined within the walls of an English department will bother to read them. Oh, sure, we all love a well-turned sentence or biting satire. The problem is that social commentary is deadly dull once you're out of the immediate environment that produced it, and well-turned sentences tend to lose their luster after a hundred years or so, when the literary fashion or the language has changed. The only things that endure are character and plot.
Ever read Gulliver's Travels? Not careful excerpts or adaptions; the whole thing. I have, about eight times. I wrote my senior thesis on it. Actual enjoyment of the work is left for people who can learn to read early 18th century English well enough for it to feel natural, painstakingly wade through all the references, immerse themselves in the history of the era -- and then get a belly laugh when Swift skewers Walpole. Now, how many people are going to do that? And that's Swift's easiest work, outside of his verse. Try to read Tale of a Tub sometime. After about three pages you'll be too tired to look at all the footnotes. After ten, you'll decide that it's really long past time you got to regrouting the tile in the guest bathroom.
Yet we still rever Gulliver's Travels, Robinson Crusoe, and Pamela not for their social commentary, but for their prodigious invention, their compelling imagery, their plot. Shakespeare is still read today not only because his language was vivid, but his characters are real. King Lear is as fine a piece of human drama as has ever been written. The Taming of the Shrew may be un-PC, but it's still hilarious after more than 400 years. A good stage production of the Merchant of Venice or Macbeth can keep you on the edge of your seat for the entire four hours. Hamlet is -- well, frankly, a little uneven, but what great soliloquies! He is not read today because he had something compelling to say about rampant consumerism at the Elizabethan Court, but because he had something compelling to say about the nature of man.
In a hundred years, when the current political winds have died down and the literary fashion has altered, who will care to read Dom DeLillo? His work has flashes of sublime prose, but they are interleaved with a great deal of dross. And his characters? Yawn. His plot? 'Scuse me, did I miss something? I can find twenty trendy authors from the 1920's with the same mix of characteristics who will be remembered not even by most graduate students in English literature today.
And even the more famous authors from that era -- how are they faring? In inverse proportion to how many circus tricks and social themes their authors piled into the work. Compare Hemingway to Dos Passos. I've been re-reading ol' John recently, and I'm afraid I spend less time thinking "How brilliant!" than "My, what a lot of work he put into all those passages everyone skips over because they're hopelessly out of date."
Now take Infinite Jest. I read rather more of it than I would have liked trying to find out what, exactly, everyone was talking about. Going back to the reviews, I found out: his sprawling, silly plot with its one-dimensional characters, stiff dialogue, and exuberant use of extremely obscure words. I could have gotten the same experience, in other words, by watching Buffy the Vampire Slayer and reading a dictionary.
[As a side note, I am more than a little shocked by the number of reviewers who talk about his incredible vocabulary. You would think that his books had been written under the same conditions as the SAT. Given the extreme obscurity of the words used, and the sheer number of them, I have a hard time believing that these were words he came across in the course of his regular reading. His "singular achievement" is open to anyone with time on their hands and access to a library with an O.E.D and a Roget's.]
Our current crop of literary wunderkinds will be little noted nor long remembered. Yet I think that probably Robert Heinlein and Isaac Asimov will still be around in a hundred years, much as we still read Wells and Verne. I think I've just formulated Jane's Rule: The longevity of one's work is inversely proportional to the pomposity of one's proclamations about one's Art.
Of course, that seems to indicate that this blog will be around forever. And doesn't it feel like it already?
Tee-hee! Ted Barlow on how Americans rank as tourists.
I had an interesting experience the other day.
Someone in the office said "French people use their forks funny."
And I said, "It's not funny, it's the European way."
My European co-worker said "Thank you! I've been saying for years that Americans use their forks wrong."
Wrong? 'Scuse me? Wrong? My ancestors were using forks when yours were still digging it out of the bowl with their fingers, my little serf. Exactly who are you calling wrong?
Which led, inevitably, to a discussion between the Europeans of the Horror of the American Tourist.
Now first of all, American tourists may have their drawbacks, but at least we don't send out our middle aged men in Speedos or flourescent short-shorts to terrorize the denizens of foreign lands. Nor do we gather our entire tour group 'neath the hotel window at 6 am to sing all 87 verses of the company song before trouping off to photograph every inch of the country, including the public restrooms and highway underpasses. Our sports fans and other assorted loonies do their rioting at home, on their own tax-payer dime, rather than travelling to someone else's home in order to destroy the property of none-to-rich citzens and commit felonious assault upon the native gendarmes. And as for not speaking the language, it isn't American women you find at every local watering hole terrorizing a busboy who speaks no English with the invocation "Excuse me! I need to go to the loo!", repeated louder and slower after each of his attempts to communicate the fact that he doesn't understand a word she's saying.
And second of all, Europeans get no sympathy from me because I have never, ever seen an American, upon finding out that someone to whom they were speaking hailed from another country, say, "Oh, I hate your country!" and regale the guest to our shores with a half-hour litany of why the foreigner's country, culture, and customs are utterly repulsive. Yet I have not only repeatedly met with this treatment on each of my trips to Europe, but also found, when I repeated them to a native of whatever country I was in, that my putative host defended this behavior with some variation on "Well, you have to admit they're right."
I know that some of the more lackwitted and boorish citizens of my country say similar things to some of the guests on our fair soil, but when such incidents are related to a crowd of Americans, the universal, instantaneous reaction is horror. I have never once heard an American say, "Well, you have to admit -- France is a horrible little country and pretty much everyone in it is a cowardly crypto-fascist. Of course, it was very rude to say it like that when you'd only just met. But still, he had a point."
Even more interesting was that when I required my interlocutors to actually list the things that Americans did that were rude, they were either wild exaggerations, or not actually rude. One person mimicked an American sitting in a cafe with his feet on the table, drinking and waving his arms wildly around. But I've been to Europe. I have eaten in cafes there. I have never, ever seen an American walk into a restaurant and put his feet on the table, at home or abroad. My interlocutors had lived here and there for many years; they conceded that perhaps Americans didn't do that, but they did slide down farther in their seats than Europeans, which looks sloppy.
They wear sweatshirts with the names of their colleges on them.
They tip too much.
They talk loudly. Annoying, yes -- but rude? Inconsiderate, if people around you are trying to carry on a conversation. But my interlocutors said that no, the Americans didn't talk so loudly that you couldn't carry on a conversation -- they were just louder than the Euros.
They spend too much money.
They brag.
They don't learn anything about the country they're in and don't speak the language. Except that according to the survey Ted Barlow is talking about, they do. And in my experience, unless the country they're in is England, Spain, Italy, France or Germany, the Europeans don't either. Of course, they may be under the impression that these five are the only other countries.
In short, Americans have a different style. The Euros find that aesthetically displeasing -- I can live with that. I feel the same way about European plumbing. But having a different style is not rude.
Of course, individual Americans are rude. Horribly rude. I know, because all the rude Americans seem to commute to New York n in order to share my subway car each day. But so aren't individual Englishmen, Frenchmen, Germans, Spaniards, Italians, Portuguese, Belgians, etc. etc. etc.
As a group, we're getting a bum rap. And you can have my wardrobe of Univeristy of Pennsylvania athletic gear when you pry it from my cold, dead fingers.
Now, the next topic I want to address is this ridiculous Princeton/Yale thing. For those of you with better things to do than watch Fox News at 3 am, the Princeton admissions office was apparently logging into the Yale admissions office's server to check whether desireable candidates had been admitted.
It makes me ashamed to be in the Ivy League, even in its outer suburbs.
Not, mind you, because I expected higher moral standards at the Ivy League. If you want moral standards, go to the University of Virginia. The Ivy League long ago abandonned any attempt to inculcate virtue into its charges in favor of nurturing their delicate little psyches. Judeo-Christian values are so, you know, middle class.
But the entire thing is so mind-bogglingly dumb.
Of course, I shouldn't expect that high a level of mental acuity in the Ivy League either. After all, I was there. After you've had an argument about the future of capitalism with an honors Poli-Sci student who can't:
1) Define capitalism 2) Define imperialism 3) Understand why the Roman Empire shouldn't be classified as a capitalist society, given its imperialistic history 4) Define communism 5) Define the difference between communism and socialism 6) Understand when you tell him that the Soviet Union, while embracing the communist ideal, was not actually living under a communist system, since the state hadn't yet withered away. 7) Define the difference between a libertarian and an anarchist. (I don't mean come up with a perfect definition; I mean come up with something more accurate than 'Libertarians just don't want the state to do anything because they hate taxes)
. . . you begin to suspect that the much-vaunted system for separating the wheat from the chaff may have broken down somewhere.
Probably in the admissions office. As in most colleges, the admissions office is a refuge for graduates who haven't found themselves positions elsewhere. They do get traded around, but the Ivies being the Ivies, the admissions office at an Ivy League school is generally staffed mostly by graduates of one of eight Eastern schools founded by people who wore wigs and knee breeches and prayed a lot.
And yet when they were caught, the best lie that the Princeton admissions folks could come up with is that they were checking the security of the Yale system? This is a brow-furrowing, ear-cupping, head-shaking, "did he actually say that?" concrete-buoy of a lie. This is Richard Nixon going public to tell the nation that his Secret Presidential Task Force had just been making sure that the door locks at the Watergate met federal safety standards.
Which begs the question: how did the folks in the admissions office get through four years of an Ivy League education without learning that the proper response to a crisis like this is to blame it on the guy that no one in the office likes?
This level of stupidity is matched only by the soul-searing idiocy of the folks at the Yale Admissions office and their friends in the Yale Information Technology Department. Such a system should never, ever have been accessible through the web. If it was, it should never, ever have used something as stupid as a student's name and social security number, sans password, to access the files. And if it had to use those things because the heads of the fun folks in the Yale Admissions Department's were too full of plans for Newport weekends and the release date of the latest Moby album to cram in a new password, one would think that elementary common sense would tell one to deny access to anyone whose request emanated from any IP address range assigned to rival institutions of higher learning that might conceivably have interest in the information. Papers keep describing Yale's system as having been "hacked". Hacked? No self-respecting hacker would stoop to that kind of entry; it's like breaking into a house that has the door unlocked, a welcome sign out, and a cooler full of icy beverages awaiting the burglar when he deigns to step inside.
Of course, no burglar would. Because if you saw such a house, you would probably suspect that it was a trap set by the police. If, that is, you had sense enough to come in out of the rain.
One begins to suspect that the Yale admissions folks weren't quite as stupid as they're letting on.
The Weissblog has a fine rant about the Salon blogging initiative. Personally, I haven't much of an opinion on the matter, but I do enjoy a good rant now and again.
What I was really struck by, however, was one of the new salon bloggers in the comments section who thinks that the publicity is worth the price. Honey, you're barking up the wrong tree. I say this as someone who has really quite a lot of readers. More than I ever in my wildest dreams imagined. And I love each and every one of you. I have absolutely no idea why you all come to read me every day as opposed to any of the other outstanding blogs out there, but I'm deeply grateful that someone wants to listen to me. I had a difficult childhood, you know. But I digress.
The point is, that my entire publicity effort for this blog consisted of one (1) letter to Glenn Reynolds and one (1) letter to Rand Simberg. It's not that I mind other people publicizing their blog to me -- we've all got to get started somehow. But other than Pej and Jim Treacher, I can't think of blogs where this approach has actually been successful, and with Jim it only works because he's got funny cartoons to back it up, and with Pej it only works because he's an outrageous flirt, and also, he threatens to kidnap your family members and kill them if you don't link to him. I'm very fond of my family members.
Ads? Worthless. Indiscriminate emailing? Pretty much worthless. The only thing that will drive traffic to your page is getting people to link to you. And the only publicity I've seen that really works is making insightful comments on other people's blogs and leaving your URL -- or doing the same over email. "I'm Here" is not a workable ploy -- so are 100,000 other people, sweetie.
No, the only thing that will drive traffic to your page is -- well, clearly not brilliant content, because in that case what are you people doing here? No, clearly what sells is bullmastiff pictures. Well, I'm going to meet that demand with more, and better bullmastiff pictures. From now on, Sunday will be Bullmastiff Snap of the Week, starring my own beloved baby, Finnegan.
Excellent piece in Salon asks why, if tech CEO's are too busy running their production lines to pay attention to the accounting, the stuff they sell us doesn't work so good.
Excellent, excellent post on antibiotic resistance from Paul Orwin. My exposure to biology education pretty much ceased after 10th grade. (Jane really, really doesn't like dissecting things. Another great medical career ruined.) So if I can understand it, you definitely can.
Meanwhile, MedPundit and MedRants have come back at me to say that pharma marketing is excessive.
But I think that we're arguing two different things. MedPundit and MedRants would like to see marketing dollars spent on other things. In the case of much of it, so would I. But I accept that the money spent on marketing is the cost of attaining something I think is more valuable than the money lost: a pretty good market, and pretty efficient research system, for pharmaceuticals. I think that practically, the only way to eliminate the marketing would be to nationalize research, and I think that the cure would be much, much, much, much, much, much, oh, very much worse than the disease. And just as MedPundit and MedRants can undoubtedly explain to you the many unattractive ways in which health care would suffer if medical care were nationalized and physician salaries were to top out at around 100K (the top rank of the federal civil service) for a doctor with 20+ years in, they can probably understand my belief that we could expect the same fine results from nationalizing the pharmas.
So I agree with them that there's a problem; I just don't think that there's a good solution. And when it comes to sweeping market interventions, I've got a memorable motto:
Okay, I've been meaning to blog this outstanding article by Joanne Jacobs on economics education, but I kept forgetting. Anyway, go read it; it's a fine, very scary story -- you have to turn all the lights in the house on and check the doors and your bond portfolio, and you still get that crawly feeling in your spine.
There is a theory, which I basically buy, that a bear market will only end when investors have capitulated, which is to say that they believe, really believe deep in their greedy little hearts, that the market is going down.
Professionals are thus waiting for capitulation so they can buy.
But capitulation is a lot like Santa Claus: everyone waits for it, but no one ever sees it when it's there, only when it's gone. As the inestimable Max Jacobs said, "Every time people I work with tell me they think the market's capitulated, I say 'No, no! The fact that you're saying that means it hasn't capitulated yet!". (Max speaks with a lot of exclamation points. It's a trip.)
I was ready to believe, after yesterday, that capitulation was finally on the horizon. But not now. It's too soon. The indices are still too high for my taste -- when you've been in a boom as long as ours, the market should overcorrect on the way down as well as the way up. If it doesn't, it means years of doldrums in the market while we wait for valuations to catch up. And I really mean years. The 60's bubble didn't correct far enough -- and the Dow was at approximately the same level in 1982 as it was in 1968.
I think that the "buy on the dips" folks went back for one more go. This time, they thought, it had to be over.
And I think that over the next few days, the profit takers are going to sell out again. And the indices will fall, again.
This is interesting. Today I was reading a US News article on the collapse of the bubble, in which the author claimed that the only thing saving us from worse malaise was the rising housing market -- but that's okay, because the incredible rises in housing prices are perfectly sound. A bell went off in my head -- doesn't this sound a lot like arguments I heard in 1998-99 for why Yahoo was really worth $200 a share? -- which was not helped by the incredibly thin reasoning behind the authors' assertion, which basically boiled down to "You know, tight zoning restrictions make housing worth more". You out there in Kansas with the house that's appreciated 50% in 4 years -- don't worry. You're just like that Dutch guy who bought Manhattan for $24.
And then I find that the chief economist for Morgan Stanley has been saying pretty much the same thing, except, you know, smarter.
By any standard, this is an aging housing cycle. For starters, it is the longest upswing of new home construction of the post-World War II era. It’s now in its eleventh year, more than double the length of the typical upleg of a homebuilding cycle. Yet the latest numbers on the supply side of the housing market are starting to look a bit toppy. As of June 2002, total housing starts are off about 6.5% from their February 2002 high. However, they have a long way to go on the downside if this is indeed the turning point. At an annualized rate of 1.7 million units in June, housing starts remain 10% above the long-term average (1.5 million units from 1959 to date) and more than double their 1991 lows. Even so, the demand side -- as gauged by trends in home sales -- remains firm. Since early 1995, sales of new and existing homes combined have risen by 36%, well in excess of the 27% cumulative rise in real GDP over the same period. At the same time, house-price appreciation is now beginning to edge off -- a classic end-of-cycle early warning sign. House-price appreciation moderated to a 6% YoY rate in early 2002; while that’s a discernible slowing from the heady 9.3% peak rate of price appreciation in 1Q01, it is still a relatively vigorous increase in an otherwise low-inflation climate.
A downturn in the housing cycle could prove to be a formidable problem for the American consumer. That’s because individuals have become overly reliant on property wealth. Currently (1Q02), the value of household real estate assets stands at 159% of disposable personal income; while that’s down slightly from the record 162% in late 2001, it’s still equal to the prior peak hit during the housing bubble of the late 1980s. Moreover, since the popping of the equity bubble, there has been an important shift in the mix of household sector wealth. At Nasdaq 5000 (1Q00), household equity holdings of $9.4 trillion were nearly double the net equity of $5.6 trillion in residential real estate; by contrast, only two years later (1Q02), household equity holdings had fallen by nearly 40%, to $5.7 trillion, whereas net property wealth increased by 20%, to $6.7 trillion. Once again, the home is the average American’s most important asset.
There's some pretty good evidence that the stock market was effecting the real economy in 2000 through the wealth effect. The wealth effect is the tendency of consumer demand to increase when they perceive themselves to be richer -- as when, for example, their 401(k) increases by 50%, and they decide that since they're going to be able to retire rich at 50, they might as well take out the plastic and spend some of that money right now. This helps to explain the massive increase in consumer debt in the last half of the 90's.
Well, even after the bubble burst, housing prices continued to rise. This seems to have mitigated the bursting of the wealth effect bubble (as did the fact that investors still don't seem to realize that 10% real returns year-on-year aren't coming back); people's 401(k)'s were going down, but they were able to tell themselves "Well, there's always the house." It also allowed people to borrow in order to continue the standard of living they'd learned to enjoy back when we were all going to be millionaires any day now: home equity loans, bigger mortgages, even credit card debt fueled by the knowlege that you could always consolidate.
What Roach is saying is that this is the last piling standing in the flood -- and it's about to come down. So it may be time to get out on the roof and holler for help.
Brad DeLong links Robert Rubin's assessment of the Bush economic team. He says that it's "unsurprisingly" negative, although I don't know if that's a slur on Bush or Rubin. But looking at Rubin's prescriptions, which are very fixated on capital markets, it got me thinking about the top folks in the Bush economic team, and the top economic players for the Dems. This is a question, not an answer, so Democrats please avoid jumping down my throat but: is part of the 90's bubble do to the fact that Clinton's economic team was obsessed by the market?
THose enamored of the New Democrat model have made much of the Clinton administration's connections to Wall Street. Not that this is a bad thing; I'm just thinking about the reforms they tout as the Clinton revolution, and most of them revolve around the Federal debt markets. Now, don't get me wrong, I'm all for deficit reduction, but the benefits claimed from deficit reduction are all out of proportion to what could actually be achieved with such a primitive tool. And the Clintonistas seemed to judge the health of the economy primarily by the health of the stock market -- which makes one suspect that their lower-level policies focused on keeping valuations high, and not bursting the bubble.
Of course, I thought the market was in full bubble back in 1998, so I'm probably not the person to trust on this issue. But I'm curious what other people think: did the Wall Street connection cause Cliinton economic policy to focus too hard on the markets?
All right, I've gotten enough emails on the subject that it's time to explain something about pharmas. I'm afraid the explanation may be a snooze, since it's complicated, but hey -- I had to give it the old college try.
Question: But why can't the pharmas just cut their marketing budgets instead of R&D? Marketing is an even bigger expense than R&D is!
Answer: Because they're mean heartless bastards who want all of their potential customers to die so they can't buy pharmaceuticals from rival companies.
Ha-ha, just kidding. Well, the answer is in two parts. First of all, marketing isn't a much bigger number; its the same as, or less than, R&D. All those figures you see showing how marketing is twice R&D or more are using a figure called SG&A -- Selling, General, and Administrative expenses. This isn't just marketing, it's everything that takes place outside of a factory or a lab. Finance. Accounting. HR. Payroll. Sales. Purchasing. Distribution. IT. Internal auditors. Retarded children on Arthur Anderson's payroll who need to be kept well supplied with Tootsie rolls less they disallow the company's treatment of capital expensing. Hotlines to deal with customers calling to find out if going on Ortho-TriCyclin will really make their skin clear up. Lawyers to deal with customers who think that Ortho-TriCyclin made them gain eighty pounds and kill their mothers. And regulatory compliance officers to make sure the Feds don't shut the place down.
Actual marketing figures are somewhere in the neighborhood of half that -- whether they live next door or on the other side of the 'hood, we can't tell, because pharmaceutical companies keep a tighter reign on these figures than fathers of thirteen year old girls do on their daughters. Anyway, marketing expenses are either the about the same as, or less than, R&D expenses. They certainly aren't more -- even Qualcomm, which has no regulatory overhead and doesn't do anything but R&D, has SG&A about equal to R&D.
However, of that marketing figure, about half consists of free samples given to physicians. While that could potentially be cut, it wouldn't save the consumer much money, since drugs they don't get for free are drugs they have to buy on a trial basis. Since many drugs are packaged by the month, this wouldn't help us in our goal of lowering consumer drug costs through allowing drug reimportation. But we're getting off the topic, which is "Why can't drug companies cut marketing expenses instead of R&D".
The second answer is to do the math. The average savings on on-patent drugs, by my survey, is about 40%. The entire SG&A budget is 30%. Even if they shuttered the headquarters and somehow managed to operate without any of the services enumerated above, that still leaves 10% of revenues to be saved somewhere else. Either they stop making the pills, they tell the stockholders to go hang and thus cut off their access to capital -- or they cut R&D.
But the most interesting answer is this: R&D is not a budgeting question. It is an investment question.
What does that mean?
The people who are asking the question are looking at the static budget from a one-year perspective: prices have been cut, so we need to cut costs. Do we cut marketing or R&D? Since they know that pharmaceutical companies currently rely on innovation to drive future profits, and they have absorbed folksy aphorisms about not eating the seed corn, they are therefore assuming that the last thing pharmas will want to do is to cut R&D. That's not an unreasonable assumption, but it is ignorant of the way that companies make investment decisions.
How Companies Decide What to Invest In When a pharmaceutical company decides whether to fund a project, the executives on the budget committee don't say to themselves "Well, can't eat the seed corn -- this year we're putting $2 billion into R&D". R&D is funded on a project-by-project basis. And each project that is funded goes through a valuation process that estimates the potential cash flows from a drug, and then discounts those cash flows by the risk that the drug will never make it to market. In pharmaceutical companies that risk is extremely high: 999 out of every 1000 compounds they explore never make it through the development, patent, and regulatory approval processes.
Now, when a project that you want to put, say, $1 million into only has a .1% chance of producing a successful drug, the size of the potential market for that drug has to be, in a totally risk free environment with no interest, $1 billion just to break even. Are we clear so far?
Okay, it gets more complicated still. Because pharmaceutical companies don't live in a risk-free environment. Nor can they borrow money without interest. So the market has to be even bigger. Assuming that time from initial research on a compound to a drug hitting the market is about fifteen years, and assuming a real interest rate of 5%, the market would have to be over $2.5 billion just to break even.
But of course, pharmaceutical companies don't just want to break even; if they did, they'd just park their cash in inflation-indexed bonds and go home. They need to make a profit. And they have a fiduciary duty to their shareholders to make the best profit possible. The rate of return on an investment therefore has to be better than the best alternative to making that investment: plunging it into the stockmarket, say, or buying a fur-bearing trout ranch in Iowa. Call it another 5% they need to make per year. Our $1 million investment now needs a potential market of $5 billion just to make the bare minimum profit that will induce the pharmaceutical company to invest.
But the pharmaceutical companies don't expect to earn back all their money in one year; they expect to earn it in the 7-10 years after it clears the FDA and before it goes off patent, using a complicated formula that takes into account the time it's been on the market and a host of other things. Based on the figures above, your $1 million investment would need to generate expected revenue of approximately (very approximately) $2 billion a year for seven years.
But these are just numbers for example. For one thing, pharma investment isn't quite that simple; put small amounts of money into a lot of things, and then when they see what looks promising, they put a lot of money into a few. But while these figures are jackleg, you can see the principle in operation: Investments are not priced on a budgetary basis. They are priced relative to the next best alternative for the money.
That is why the R&D budget now exists independantly of the marketing budget: this year's marketing budget was already priced into old projects.
Why Can't We Just Cut Marketing In the Future? Now you're going to ask me why we can't factor out the marketing budget in the future on the assumption that doctors and patients will just find out about our product by word of mouth and drive over in their cars to pick some up. Let me 'splain.
First of all, if a lot of that marketing budget was gravy, companies wouldn't do it. Oh, there are junkets for the doctors. But most of the budget is getting the drugs to the doctors, and telling the doctors about them. Doctors need to find out about the drug somehow. Doctors will tell you how useless most of the marketing budget of a pharmaceutical company is. This is because doctors have absolutely no idea what the relative cost is of, say, doing a mass mailing or advertising in the AMA journal, vs. taking doctors to dinner, taking them to a hotel, or giving them free samples. Doctors in what I like to call the "lifestyle professions", such as dermatology or podiatry, are also quite vocal about the uselessness of free samples. Free samples, however, ease the transaction costs of taking a new drug for people with serious illnesses, who often have much less disposable income than someone spending time and money at the dermatologist's. For example, I'm now on Singulair. But Singulair only works at all for 65% of asthma patients, and it comes packaged as a one-month supply. Who wants to spend money on 30 pills to find out that you don't need 28 of them because the drug is useless? Fewer samples mean fewer sales to people who don't want to spend $200 to find out if that new blood pressure med works.
So let's assume that we can cut a wildly unrealistic 30% out of the marketing budget in the future. This amounts to, by current budgeting, 5% of revenue.
More importantly: Marketing is not an expense subtracted from the potential profits of R&D. It's a different investment.
Viagra didn't need marketing. Tell people it's there and they'll line up for hours in the rain to get their hands on it.
A project is generally anticipated to make most of its money in three or five years of its patent life; that's when the planners anticipate recovering most of the initial investment, before newer better drugs come on the market, or the patent expires. Much of the marketing happens outside of those 3-5 years, generating additional revenue that wasn't factored into the investment equation. This revenue is important as a source of profits to generate more capital for research -- but it is not factored into the initial calculation of the profits required to recover the initial investment, and therefore cannot be factored back out again.
Now, I need you to make another assumption: to wit, that most current projects in the pharmaceutical area are projected to return very close to the minimum needed for a company to fund them. Why should you assume this? Because economic theory tells us that if it weren't so, there would be tons of new entrants into the market, attracted by juicy profits. In fact, there have been just such entrants -- that's the biotech sector. And they have competed down rates of return -- that's those "me-too" drugs you hear everyone complaining about. Guess what? Those me-too drugs are making you pay less for your pharmaceuticals, not more. Now, if a compound looks like it will generate an especially outsized return, you can bet your bottom dollar that all the other companies are working on a compound for that disease too. Having two compounds on the market for the same thing will cut deeply into your expected return.
Okay, so most projects are expected to return very close to the minimum needed to make them a worthwhile investment. Now, let's assume that reimporation becomes law. Prices are expected to drop by 40%. What happens?
What Happens if We Drop the Price of Drugs? Now, pharmaceuticals are different from, say, tube socks because there is an absolute limit to their market. Even if they're giving them away for free, healthy people aren't going to start taking Prozac or HIV drugs or blood pressure medication. In addition, a large portion of the people who are currently priced out of taking drugs will not start taking them even if you drop the price. Why? Because they can't afford the doctor's visit either. Dropping the price on a patented drug thus garners many fewer new users than doing so on a normal product. Losing 40% of the price therefore means that the firms also lose close to 40% of the revenue.
Let's say that they only lose 25% of the potential revenue. And let's say that they can cut their marketing costs by 30%, yielding a savings of 5-7% of total revenue. This cuts their total loss to 17-20% of revenue. Will the pharmaceutical companies invest in new R&D?
Not on most projects. The projects simply will not earn back the required rate of return to justify the investment of capital. Even though you may reason that pharmaceutical companies today could lose 25% of revenue and -- just -- survive, they still will not invest in projects in the future which do not return their cost of capital.
The projects that are invested in will only be for very large markets, where it is possible to remain profitable with volume, or lifestyle drugs where there is no downward political pressure on the price. Cancer is not a large market; there are many different kinds that respond to different things. AIDS is not a large market. Most markets, in fact, are not that big.
I know that those of you who wish, very deeply, to believe that we could make new drugs cheap if we just tried a little harder, cannot believe this. So let me explain why you can't, even with very deep cuts in the marketing budget, make R&D profitable at lower prices:
Time.
Because of the regulatory process, which eats 7-10 years of the patent life of drugs, Pharma has the longest development cycle of almost any industry -- the longest time between the initial investment and the payoff. The farther out things are in time, the higher the risks, the lower the time value of money, the longer the discounting has to work. So when the initial positive cash flows from an investment are very far out, the profit margin in the first years of positive cash flow must be very large to compensate for the length of time the capital is tied up. You simply cannot cut those revenues by 25% and still cover the profit margin, even if you manage to cut costs by the same percentage -- and you can't.
Think of it in terms of your own life. Imagine you currently make $100 K, and have living expenses etc. of $80K. You're offered a new job at $90K. When you point out that this is 10% less than you're making now, the interviewer replies that since you can live in a less expensive neighborhood close to your new job, you'll be able to generate savings of 10% on your cost of living, too. Do you do it?
Not unless you're stupid. If you do, you lose $2,000 of net income.
Even if the management of pharmaceutical companies wanted to take on projects the value of which doesn't exceed the value of the best alternative use of the capital, the shareholders wouldn't let them. They'll stop researching pharmaceuticals and invest in something else. Shampoo. Chemical solvents. Fur-bearing trout farms. Something that covers the cost of the capital required to make the investment.
Summary Explanation So the reason that R&D dollars will be cut before marketing dollars is first of all, that it is mathematically impossible for most drugs to recover their cost of capital if their price is cut by 40%; and second of all, that cutting prices actually biases investment decisions towards marketing and away from R&D. Why? Because marketing has a very short time horizon. No discounting. So the dollar return required on an investment in marketing is lower by an order of magnitude than the dollar return on an investment in R&D. If you are faced with drastic cuts in prices and revenues, the first investments to go are going to be the ones that require a large revenue return for each dollar invested -- in other words, R&D. So while theoretically, it would be physically possible for pharma companies to substitute cuts in marketing for cuts in R&D, it would be irrational for them to do so.
It's a hard topic to explain, and I'm not sure I'm doing a good job. But this is why people doing back-of-the-envelope arithmetic are confident that they could still do R&D with the new pricing -- and investors and pharmaceutical analysts know that it won't happen.
A couple of people have emailed me to ask what's going to happen in the stock market this morning. Tee-hee! If I knew that, I would even now be on the phone with my broker placing the appropriate bets, and I would not publicize the results until I had made a killing. Unfortunately, I'm as ignorant as everyone else. To wit: I predict that it will either go up, go down, or remain flat.
Now, the most likely occurrence is that it will go down. As the head of the New York stock exchange, in a miracle of understatement, said, our experience with Monday markets after sharp Friday declines is not good. What he really meant to say is that our experience with Monday markets after sharp Friday declines is that they plummet like a fragment of a neutron star thrown from the top of that uber-tall building in Kuala Lampur.
You see, a lot of people got hurt on Friday. And they've had a lot of time to brood about it -- all weekend, in fact. They have envisioned their altered retirement plans, priced Friskies, started looking out for a nice refrigerator box they can pick up on the cheap. And then on Sunday night, after a long series of arguments with the spouse about whose idea it was to put all the retirement savings in tech stocks, along came the news that WorldCom is going bankrupt, reinforcing their belief that they'd be better off changing their money into singles and using it to economize on toilet paper than giving any of it to those crooks in Corporate America. All of those people are panicking and looking to sell at any price.
On the other hand, there are still people out there who believe in "buying on the dips" -- people, that is, who still haven't quite learned that the 90's are over. These people are busily subsidizing the day traders and panic sellers. While "buy on the dips" seemed like a genius strategy when the market was rising, these days it works like this: you buy on the dips. People who have been waiting to take profits or avoid losses sell as soon as the stock rises a little. This makes the stock fall further.
[Standard Jane rant about equity valuations: Right now, the S&P stands at 32 times earnings. While the P/E ratio usually does rise at the bottom of a recession because earnings are very depressed, this is still nearly 50% higher than the historical highs for S&P P/E's. We used to think that the abnormal ratio meant that the risk premium on equities, the higher rate of return that investors demand on stocks compared to risk-free treasury bills, had gone down. Oops. Turns out that the risk premium was only lower when investors thought that stocks could only go up, or in other words, were mispricing the actual risk. Now it looks like the S&P et. al. have to get back somewhere near that 20 mark for the market to have actually bottomed. Maybe earnings are so depressed, and the risk premium is sufficiently altered, that it will bottom at 25. But probably not at 32. Remember, the spectacular rises before were fueled by everyone pouring all their spare cash into the market. That's not coming back. Even if the market bottoms now, it probably won't go anywhere much for a couple of years yet; people simply are not going to come back at the previous volumes. People are scared, and they're diversifying out of equity. Sensibly so. But it's hard to see how they can support P/E's of 32.]
Anyway, the point is not to make fun of people who buy overvalued stocks in the mistaken (IMHO) opinion that they are undervalued; the point is to note that they are a countervailing force against the market falling, and if there are more of them than panicky investors, the market will rebound. However, I personally think that any rebound will be what's known as a "dead cat bounce", which refers to a trading axiom that even a dead cat will bounce -- once -- if it falls from a sufficient height.
Or the market could do nothing much. This will happen if there are about as many "buy on the dips" people as there are panicking people.
But there's no way to know how many people are panicking, vs. how many are plotting to stake out new equity holdings, because there's millions of them all sitting in their offices, livingrooms, or cars, right now, and they haven't phoned me to let me know what they're thinking. The only thing to do is wait.
