Genentech’s Q3 Highlights Healthcare Cost Issues

There is little arguing that the rising cost of healthcare is one of the biggest issues hampering the U.S. economy. Next year, average health insurance premiums are expected to surpass $14,000 per family. That will represent one-third of the average household income in this country. The main reason for such staggering costs are prices for prescription drugs. Drug expenditures, which were $12 billion in 1980, hit $179 billion in 2003. That’s an average increase of 12.5% per year, more than 4 times the historical rate of inflation.

Investors need look no further than the Genentech (DNA) Q3 earnings report to see exactly how crazy drug prices have gotten. Genentech’s newest and second-best selling drug, Avastin, costs a whopping $140 for a day’s supply. That equates to $4,400 per month and $53,000 per year. Should a drug for colon cancer really cost 20% more per year than the average household income in the United States? I bet very few could argue it should.

The argument for limiting the costs of prescription drugs centers around the idea that limited profit potential will result in less research and development, and therefore fewer novel therapies for the world’s most lethal diseases. Without the ability to make a significant profit, proponents of a healthcare free market say, drug makers will lose the incentive to discover new drugs for cancer, heart desease, etc.

However, a simple analysis of Genentech’s third quarter income statement shows that this theory, while it makes sense in economic terms, simply isn’t true when you actually look at the numbers. Here are some key facts from DNA’s latest earnings release:

* Genentech’s drug mark-up (retail price versus manufacturing cost) is 662%

* Only 38% of the drug company’s profit is reinvested into research and development, and net profit after tax actually surpasses total R&D expenditures

* Drug company net profit margins are nearly 20%, higher than any other major industry

And the one that is important to understand when hearing the debate on spiraling costs for prescription drugs:

* If retail prices for Genentech’s drugs were reduced by 50% effective immediately, the company would still be able to spend the same amount it does today on R&D and would have more than $400 million left over in excess profit every year