January 16, 2003
From the desk of Jane Galt:Advertising, Marketing, and SG&A: or, how consumer groups lie with statistics
A number of you have asked how I could possibly claim that Pharma only spends 1% of revenue on advertising, when y'all have seen numbers from consumer groups that run 30%. Well, I got that number from an industry group, but they provided backup. (I can't find the link now, sad to say)
One should, of course, qualify that number, since in position papers like these, things are rarely what they seem. The advertising they are discussing is consumer advertising, not advertising to doctors, which is a very large expense. They backed it up with numbers on overall industry revenue and numbers from some advertising group on pharmaceutical advertising revenue. However, the percentage spent on advertising expensive drugs will be much, much higher than that. It's just that, although they're popular, expensive drugs do not actually make up the majority of industry revenue.
But although I certainly wouldn't have put it past the industry group to portray themselves in the best possible light, I know the consumer groups are lying. Or rather, stretching the truth into new and interesting shapes. The number they are calling "advertising" is actually a number on the balance sheet known to accounting professionals as SG&A: selling, general, and administrative expense.
SG&A is a basket term. It includes everything that happens outside of a factory (things that happen inside a factory are COGS: cost of goods sold) or a lab (things that happen in a lab are R&D: research and development).
So how do they get there from here? Thus: first one consumer group writes a report in which they render that SG&A expense as "Marketing" to make their point a little more punchy. Now, a large component of SG&A is marketing. But it is not the only thing. If you've ever worked in the headquarters of a corporation, think of all the departments. Accounting. IT. Payroll. HR. Mailroom. Reproduction. Marketing. Corporate Finance. Sales. Those are all part of SG&A.
Somewhat counterintuitively, to the accounting layman, Sales is not part of Marketing. Marketing is the department that figures out who your consumers are and how you should sell things to them, and what you should sell; the sales department actually goes and browbeats the customer into buying the stuff. Nonetheless, one consumer group decides that it's all pretty much marketing, and then writes a report called something like "Pharmaceutical Companies: Raping the American Family for Fun and Profit", which cites the SG&A figure as the company's "marketing expenditure".
Now, advertising certainly isn't the same thing as marketing. It's a component of marketing, but only a small one. There's also professional advertising in places like the JAMA, which no one really objects to (there wouldn't be any JAMA without that kind of advertising); there's product market research and sales materials to be written and junkets for physicians. Much of this stuff may also be objectionable to many, although one should keep in mind that if the pharmaceutical firms stop paying for physicians dinners and vacations, their patients may have to start, so it's not necessarily a net savings. All of which is irrelevent, because the important part is that it is not advertising.
Nonetheless, another consumer group takes that report and writes one of their own: "Pharmaceutical Companies: Satanic Spawn Who Dream only of Murdering Our Children and Selling Their Broken Little Bodies for Mulch". This report cites that "marketing" number as "advertising expenditure". Thus we get the claim that pharmaceutical companies spend 30% of their revenues on advertising, when the real number is much, much lower than that. And thus the belief common among advocates for a single payer health care system that we can force companies to lop of 30% of the price of a drug without touching R&D.
This is wrong in two ways, of course: the number is too big, to start with, and more importantly, it misunderstands the way that companies make decisions. Consumer groups are thinking of pharmaceutical expenditures as budget items -- expenses to be cut. But you have to think of R&D and marketing expenses as an investment. Every budget season, the company allocates its funds by deciding which investment will be more profitable. The assumption is that if you institute price controls, companies will give up marketing to focus on R&D. But the reverse is likely to be the case. R&D is very, very, risky, and very long term. Marketing is perhaps risky, but very short term, and so much less investment is required overall. If you cut the potential profit on a product in half or more, a risky project like R&D has to have a stratospheric potential return to ever get funded. Marketing dollars, on the other hand, are likely to have a much bigger return, because when prices are controlled, the only way to make money is through volume -- meaning advertising becomes crucial to maintaining profitability. Who advertises more: Qualcomm, with its fat margins and high R&D expense, or Proctor and Gamble, with skinny little margins and tiny research expenditure?
So anyway, that is how I arrived at my number, and how they arrived at theirs. You may dispute my number -- but only, please, with good numbers of your own, not with some PIRG screed, 'kay?
Posted by Jane Galt at January 16, 2003 08:36 AM | TrackBack | Technorati inbound linksYou're right, SG&A includes much more than advertising. In fact, the "marketing" line may include things that most people don't think of as marketing at all..for instance, product line managers usually fall under marketing, and they typically have a lot to do with getting products created and into production, as well as getting them sold.
SG&A also probably includes customer service. There are some cases where it includes bad debt writeoffs (for unpaid invoices).
Megan,
While I love the idea of putting little shoes on the pills, you may want to change the spelling for COGS, from soled to sold.
--Stephen
Posted by: Stephen on January 16, 2003 02:16 PMHmmm...researching those numbers is a project of such magnitude that this post will be archived well before completion, but your point is well taken that those numbers will at some future point be needed to refute this same point--even though here you do not document nor use precise numbers yourself.
That being said, in the interim, perhaps a couple of contrary(ian?)points.
Could you please link to the consumer groups that generated a report with the words "satanic spawn who dream of murdering...," or "Raping America...." I understand you probably jest, yet that language highlights a visceral bias against consumer groups that clouds the entire screed. In your opinion, are consumer groups solely in existance to incite consumers?
More relevant, you say that the information you present comes via the balance sheet, from which you then proceed, by interpretation, to remove many things, including physician junkets, as not being included in a marketing budget. Your assumption that physician junkets are not marketing, and further, will still be necassary under single payer, is debatable. Moreover, equally accessible, and certainly more relevant, are the revenue/expense statements which supply the raw data for the balance sheet and from which well documented breakdowns could be retrieved. Is there a reason those numbers were not presented by the big pharma's that you are argueing so vehemently in behalf of?
And finally, on your point about marketing actually taking on more importance under single payer. The best advertising is still cutting edge developements that keep a company front and center in the public eye--that motivation will never decrease.
Yeah, gotta get the numbers.
Posted by: TonyB on January 16, 2003 04:48 PMTonyB -- you misread me. First of all, yes, it's a joke, and it doesn't reveal any particular hatred of consumer groups -- I'm an equal opportunity lampooner. Second of all, I wasn't removing physician junkets from market, only from advertising, which is a different, smaller expense. And third, that motivation will most certainly decrease if you can't get paid for your discoveries. Companies are not in it for fame; they're in it for cash.
Posted by: Jane Galt on January 16, 2003 05:29 PMI'm sure it was obvious I knew those were jokes (and amusing to boot); still, I guess I will have to read other posts to find you lampoon pharmas, because here you do not.
As to the marketing/advertising distinction, I admit my quiver is empty. I'm looking forward to friday at the pub with some of my business buddies to flesh this out.
In general, I know Beyer because I know asperin. If Bayer and other companies less known produce essentially the same drug, Beyer has a huge, built in marketing/advertising advantage. For that reason, even if asperin were not a profitable commodity, Beyer would never relinquish it's production. For this same reason, companies that develope cutting edge products naturally have marketing/advertising advantages; in fact, so much so that some R&D costs could be expensed to marketing/advertising. And isn't there a concept known as a "loss leader?"
Jane, I've got no love for PIRGers and Naderites either. I used to get into arguments with them all the time when I was in school…
One of the things I like about economics is that it allows for political discussions which don’t degenerate into arguments over which side is more virtuous. From an economic point of view, the question of whether corporations (or for that matter workers or consumer groups) are ‘evil’ or ‘selfish’ is nonsense. It’s taken as a given that all individuals and institutions will act in their own self-interest.
So when you point out that consumer groups exaggerate in order to help their cause, I think, ‘Duh!’… but I think it would be pretty wise to be skeptical of those corporate press releases as well.
Also, since we’re talking about R&D spending and innovation, isn’t it only the more expensive drugs that are relevant to this discussion?
I'm very skeptical of corporate press releases; in this case it was a number that appeared to have some backup. The industry revenues are not controversial numbers, and the figure for consumer pharma advertising was from some advertising group, not the pharmas. I freely confess that I hate consumer groups, but it was a hatred I developed through working for a PIRG, to my eternal shame.
The point is not that there is no advertising or marketing spending; the point is rather that the consumer groups, whether through ignorance or intent (I am more than willing to believe that there is not a consumer group activist in the country who knows what SG&A is, though that doesn't really let them off the hook for pretending that they do), play extremely loose with the numbers. For people who don't understand where the numbers are coming from, it's hard to understand why my figures differ from theirs, so I think it's a good idea to explain where both come from, so that people can assess the disagreement for themselves. I don't know exactly how much of that money is marketing expense. I think the advertising number is accurate. But the consumer group number is wildly overstated.
Posted by: Jane Galt on January 16, 2003 08:00 PMAccording to the reports I've heard, the major gripe of the consumer groups is not simply that pharms spend too much on advertising - it's the ratio of advertising to R&D, and the trend that ratio is allegedly following (skewed increasingly more towards advertising/marketing) that really bothers these folks.
I'm in no position to comment on the pharms' accounting procedures or the competence and integrity of PIRGs, but aside from all that, might there not be legitimate reasons why some pharms would spend less on R&D than they have in the past? The trend in a lot of industries for the last decade or more has been outsourcing. It's my casual understanding of the pharm industry that the R&D function is being outsourced by the big pharms more and more in this way: some little biotech startup in Iowa develops a new drug, then Merck buys that company, secures the patents, shepherds the new product through the FDA approval process, and takes over the marketing function. The result is that Merck's budget skews more towards advertising than R&D.
Is anybody else familiar with this trend? Are there any publications out there that discuss it? Or am I totally off base?
Posted by: Zarathustra2101 on January 16, 2003 08:23 PMJane Galt,
Have you found your source yet? I'd really like to see a consumer advocacy group report that misconstrues SG&A as advertising.
Posted by: Zarathustra2101 on January 17, 2003 01:47 PMWhen I was writing about the issue before, they were thick on the ground: just google on "drug company" "advertising" and "research"
Posted by: Jane Galt on January 17, 2003 02:03 PMComments are Closed.