Gross margin

Gross margin (GM) represents sales revenue minus the cost of goods (COG) sold on the P&L statement. This metric is heavily influenced by the pricing conditions faced by each of our companies. The higher the GM and a track record of strong GM performance over time suggests a healthy degree of market power in obtaining good prices from the customer base. What is less well known—but increasingly important in this new era of biologics—is that GM also reflects the ability to get good prices on API and other materials required to manufacture a drug: the cost of goods sold.

Here again, past is prologue, with companies having a strong specialty franchise and a selective customer base doing the best (Gross Margin table), where placement ranking goes from high (24) to low (1). Biogen-Idec, Celgene, Allergan, Amgen, and Shire take the top five spots because of their ability to wrest nosebleed prices. Significantly, we do see a slight drop in margins over 2010 for all of these companies, save Allergan. This suggests a slow market trend toward more crowded competition in the specialty space and thus greater price resistance from payers.

The EBITDA (earnings before interest, taxes, depreciation, and amortization) to sales metric (Net Income to Sales table) is a simple way of demonstrating a company's basic profitability. It is the net income from operating the firm as a business before accounting and finance issues create more smoke and mirrors. Gilead comes in first with a ratio of earnings to sales ratio of over 49 percent—which is actually down from last year—followed by Biogen-Idec and then Pfizer, which benefited handsomely from aggressive cuts in operating expenses. Forest Labs had the steepest decline in profit performance of the group as it confronted the expiry earlier this year of the US patent on its biggest blockbuster drug, Lexapro.

To put both the gross margin and EBITDA/sales rankings in perspective, compare our audit's high flyers to Apple, arguably the most innovative firm in the world. Interestingly, Apple spends only 2.2 percent of its sales on R&D, far less than the norm for Big Pharma. Apple's gross margin for 2011 was 40.5 percent with a profit margin of 35.6 percent; this is small change compared to Biogen-Idec's gross margin of 86.8 percent and an EBITDA to sales ratio of 42 percent. The data shows overall that biopharmaceuticals remains one of the most profitable business sectors, with consistent high returns close to the 20 percent range. However, it is an open question whether in the long term these big margins in pharma can be sustained, even for products with small eligible populations for which there is a real medical need.

Sales to assets

Sales to Assets

EBITDA/assets: return on assets

The EBITDA (or net profit before taxes) to assets ratio is a critical measure. It reflects how good a firm is at the two basic ways to make money: margin management and asset management. Novo Nordisk, AstraZeneca, Roche, Biogen-Idec, and Gilead shine in the Income to Assets table. All have a reputation for high levels of efficiency in using their in-house resources while working the customer base to maximize pricing opportunities. The surprise here is Teva, which scored lowest on this measure and appears to be having trouble absorbing the spate of recent acquisitions designed to diversify its offerings beyond generics.

Sales/employees

The ratio of sales to the number of employees is a basic measure of productivity: it links the revenue to the size of the company's employee base. The key is not necessarily to have the fewest workers but to maximize the revenue that each of these workers generates in the course of a year. The Sales to Employee table shows that Gilead generates about $1.9 million in revenue for every employee, followed by Celgene, Biogen-Idec, and Amgen. The differential between high and low is startling. The Gilead employee produces about eight times the revenue that a worker at Hospira or Mylan does—both are mired in commoditized business lines with low margins. It is another indicator of the importance today of smaller, highly trained, and focused sales teams able to target segmented therapeutic areas where there is the opportunity to charge premium prices because of the high unmet medical need.