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Marketing costs incurred within the ethical pharmaceutical industry Fevang, Leroy Conrad 1968

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MARKETING COSTS INCURRED WITHIN THE ETHICAL PHARMACEUTICAL INDUSTRY  by Leroy Conrad Fevang B.S.P., University o f B r i t i s h Columbia, 1958 A THESIS SUBMITTED IN PARTIAL FULFILMENT OF THE  REQUIREMENTS FOR THE DEGREE OF  MASTER OF BUSINESS ADMINISTRATION i n the Department of Commerce and Business Administration We accept t h i s thesis as conforming to the required standard  THE  UNIVERSITY OF BRITISH COLUMBIA A p r i l , 1968  In presenting t h i s thesis i n p a r t i a l fulfilment of the requirements for an advanced degree at the University of B r i t i s h Columbia, I agree that the L i b r a r y s h a l l make i t f r e e l y available f o r reference and study.  I further  agree that permission for extensive copying of t h i s thesis for scholarly purposes may be granted by the Head of my Department or by his representatives.  I t i s understood that copying or publication of t h i s thesis for  f i n a n c i a l gain s h a l l not be allowed without my written permission.  Department of Commerce and Business Administration The University of B r i t i s h Columbia Vancouver 8, Canada Date  Apr: I i>> i f 6 8  i  ABSTRACT Recent governmental enquiries i n t o the Canadian Pharmaceutical industryhave recommended t h a t the l e v e l of marketing costs incurred by i n d i v i d u a l firms be reduced, so that the cost of medication may i n turn be reduced.  The  object  of t h i s study i s to seek out and apply q u a n t i t a t i v e techniques that o b j e c t i v e l y measure the e f f e c t i v e n e s s of various pharmaceutical f i r m s ' marketing departments.  This i s subsequently r e l a t e d to the f i r m s ' marketing p o l i c i e s and  the  costs of t h e i r implementation. The e f f e c t i v e s n e s s of s i x pharmaceutical f i r m s ' marketing departments was determined by two methods: (1)  a r a t i o measure of each firm's rate of return  to the l e v e l of i t s marketing costs; and (2) a p r o d u c t i v i t y measure that permits the c a l c u l a t i o n of r e l a t i v e e f f i c i e n c i e s .  I t was determined that the  general q u a n t i t a t i v e r e s u l t s were consistent f o r e i t h e r method of c a l c u l a t i o n . In a d d i t i o n , not only was there a wide degree of variance between the i n d i v i d u a l firm's marketing e f f e c t i v e n e s s , but i t appears that firms who  adopted  an i n d i r e c t d i s t r i b u t i o n p o l i c y and a mass s e l l i n g promotional p o l i c y had a more e f f i c i e n t marketing department.  TABLE OF CONTENTS CHAPTER I. II. III. IV.  PAGE  INTRODUCTION  1  THE ECONOMIC ENVIRONMENT OF THE PHARMACEUTICAL INDUSTRY..  5  THEORETICAL APPROACH TO THE MEASUREMENT OF MARKETING COSTS. 25 ANALYSIS OF THE MARKETING COSTS INCURRED WITHIN THE ^5  ETHICAL PHARMACEUTICAL INDUSTRY V. DETERMINATION OF THE PRODUCTIVITY FOR PHARMACEUTICAL FIRMS'  VI.  MARKETING DEPARTMENTS  81  SUMMARY AND CONCLUSIONS  98  BIBLIOGRAPHY  106  APPENDIX Income Statements  109  iii LIST OF TABLES TABLE  PAGE  I . R e l a t i o n s h i p of the Number of Establishments and the T o t a l Value of Factory Shipments i n the Canadian Pharmaceutical 8  Industry I I . Pharmaceutical Establishments Grouped According to the S i z e  8  of the Value of t h e i r Factory Shipments I I I . Comparison o f F i n a n c i a l Ratios f o r Canadian Manufacturing Corporations i n 1962 IV. Comparison of P r o f i t a b i l i t y f o r a l l Canadian Manufacturers  1953  to 196^  i  W  V. Summary of Major Product P o l i c i e s  9+  VI. Comparison of Product Assortments  55  V I I . S i z e of the F i e l d Sales Force  6^  V I I I . C l a s s i f i c a t i o n of D i s t r i b u t i o n Costs i n t o Value Added and Value Contributed  83  IX. C l a s s i f i c a t i o n of Promotional Costs i n t o Value Added and Value Contributed  S%  X. C l a s s i f i c a t i o n of Administration Costs i n t o Value Added and Value Contributed XI. C a l c u l a t i o n of the Marketing Department's Economic Output ....  85 86  XII. C a l c u l a t i o n of the Value Added Output of Pharmaceutical Firm's Marketing Department X I I I . C a l c u l a t i o n of the Man-Hours of Labour Input  89 92  iv  TABLE XIV. XV. XVI.  PAGE Calculation of the Marketing Asset Input Measure  93  Calculation of the Product Input Measure  93  Calculation of the Marketing Department's Productivity Measurements  XVII.  Ranked Order of Marketing E f f i c i e n c y f o r the Productivity Measurements  XVIII. XVIX.  9^  Comparison of the Ranked Orders of Effectiveness  9^ 98  Comparison Between the Effectiveness of the Marketing Department and the Size of the Marketing Costs  101  V LIST OF ILLUSTRATIONS ILLUSTRATIONS 1.  PAGE  Direction o f Emphasis i n the Promotion of Pharmaceutical Products  •  2.  The High Degree of Substitution between Products  3.  The low  11  The High Cross E l a s t i c i t y of Demand between Products within 12  the same Therapeutic Market 5.  The Low Cross E l a s t i c i t y of Demand between Products i n 12  D i f f e r e n t Therapeutic Markets 6.  Comparison of Marketing Costs Incurred by E t h i c a l 53  Pharmaceutical Firms 7.  D i s t r i b u t i o n Channels used by the S i x Selected Pharmaceutical 56  Firms 8.  Promotional Blend of Mass and Personal S e l l i n g A c t i v i t i e s 60  used by E t h i c a l Pharmaceutical Firms 9.  Ratio of the Percentage D i s t r i b u t i o n Costs to the Size of 61  the Product Assortment 10.  11  Degree of Substitution between Therapeutic  ' Markets k.  6  Comparison of the Promotional Blends of E t h i c a l Pharmaceutical 63  Firms 11.  Analysis of Personal S e l l i n g Costs  6k  12.  Comparison of Mass S e l l i n g Blends  66  13.  Comparison of Marketing Costs Incurred by  Non-Pharmaceutical  Firms i n 1965 Ik.  73  Relationship between the Marketing Costs and the Over-all Success of the Pharmaceutical Firms  76  CHAPTER  I  INTRODUCTION Over the l a s t ten years the Canadian public has become increasingly concerned about the cost of medication and, as a consequence, there have been numerous governmental  enquiries into the a c t i v i t i e s of the Canadian  pharmaceutical industry. In 1964, The Royal Commission on Health Services recommended that "consideration should be given to establishing a maximum of 15 percent of t o t a l sales as the allowable deductable expense f o r advert i s i n g sales promotion,  'detail men', and other similar items".^  Then i n  I967, The Special Committee on Drug Costs and Prices, hereafter referred to as the Harley Report, recommended "that drug manufacturers revise t h e i r  :  promotional practices on a voluntary basis, as considerable savings could be made and passed on to the consumer".  Both of these recommendations  focused upon reducing the absolute l e v e l o f marketing costs, thereby implying that l i t t l e or no value can accrue to society as a r e s u l t of the firm's marketing expenditures and, therefore, the smaller the size o f these expenditures the greater w i l l be the benefits to society. These recommendations and their implications have not been challenged, i n a formal manner, by pharmaceutical marketers, f o r the intangible nature of the marketing functions acts as a b a r r i e r to an objective rebuttal. I.  OBJECTIVE OF THE ANALYSIS  The objective of t h i s study i s to seek out and apply quantitative techniques that o b j e c t i v e l y measure the effectiveness o f various pharmac e u t i c a l firms' marketing departments.  This i s subsequently related to  IH. C. Harley, Drug Costs and P r i c e s . Second (Final) Report, (Queen's Printers:Ottawa, 1967) p. 60. 2  I b i d . . p. 53-  2 the firms' marketing p o l i c i e s and the costs of their implementation.  The  focus of attention w i l l be upon what i s being accomplished by means of the marketing costs, rather than upon the absolute size of the costs. II.  JUSTIFICATION FOR THE STUDY  The objective of t h i s thesis may be j u s t i f i e d on the grounds that increased governmental intervention into the pharmaceutical industry may  be  expected i n the future, since the precedent has been established over these l a s t few years.  This i n i t s e l f may not be undesirable, but i n the event  that more r i g i d constraints are applied across-the-board to a l l marketing a c t i v i t i e s and to a l l firms, society may that some marketing p o l i c i e s may  be the l o s e r .  I t i s to be expected  be implemented more e f f i c i e n t l y than others.  Through the i d e n t i f i c a t i o n of these more e f f i c i e n t p o l i c i e s and firms, society may  be better  served. III.  SCOPE OF THE STUDY  The scope of the study includes an analysis of the marketing costs incurred by s i x Canadian e t h i c a l pharmaceutical manufacturers and a measurement of the effectiveness of each firm's marketing department. i s determined by two methods:  This effectiveness  ( l ) a r a t i o measure of each firm's rate of  return to the l e v e l of i t s marketing costs, and (2) a p r o d u c t i v i t y measure that permits the c a l c u l a t i o n of r e l a t i v e e f f i c i e n c i e s .  However, these  measures apply to only those marketing a c t i v i t i e s undertaken i n 1965 a r e s u l t generalizations may  and as  not be made.  The research methodology involves a l i b r a r y search where pertinent material was  extracted from secondary sources.  These include:  ( l ) The  Harley Report. 1966-7, (2) The R e s t r i c t i v e Trade Practices Commission on The Manufacture, D i s t r i b u t i o n and Sale of Drugs. 1963.  and (3) the writings  3 o f R. D. B u z z e l l on h i s work on marketing p r o d u c t i v i t y . 3 IV.  LIMITATIONS ON THIS THESIS  The primary l i m i t a t i o n that exerts an i n f l u e n c e on the w r i t i n g o f t h i s paper i s the q u a l i t y o f the s t a t i s t i c a l cost data.  The Harley Report  comprises the only a v a i l a b l e source o f cost data and i n places t h i s was sketchy i n d e t a i l .  I n a d d i t i o n , t h i s report presents the a c t i v i t i e s o f  only s i x pharmaceutical firms f o r one year.  L i t t l e co-operation was r e -  ceived, i n answer to requests f o r supplemental cost information, from most of these firms and the Pharmaceutical Manufacturer's Association o f Canada. V.  ORGANIZATION OF THE CHAPTERS  Chapter I I presents the economic environment o f the Canadian pharmac e u t i c a l industry.  I t includes a c l a s s i f i c a t i o n o f the i n d u s t r y and the  analysis o f c e r t a i n economic f a c t o r s that are c h a r a c t e r i s t i c o f the industry. Chapter I I I establishes the b a s i c t h e o r e t i c a l framework of marketing costs and defines marketing costs and marketing e f f i c i e n c y . I n a d d i t i o n , i t discusses a q u a n t i t a t i v e method o f e f f i c i e n c y measurement. Chapter IV undertakes an a n a l y s i s o f the marketing costs i n c u r r e d by s i x e t h i c a l pharmaceutical manufacturers.  I n i t i a l l y , i t takes the form o f  a f i n a n c i a l analysis i n order to i s o l a t e c o n s t r a i n t s on the implementation of marketing p o l i c i e s .  L a t e r , the a n a l y s i s i d e n t i f i e s the l e v e l o f the  marketing e f f o r t as a percentage o f s a l e s , and then d i v i d e s t h i s i n t o i t s component p a r t s .  This i s followed by the i n t r o d u c t i o n o f the l e v e l , o f  marketing costs incurred by firms i n other i n d u s t r i e s , which provides the 3R. D. B u z z e l l , Value Added by I n d u s t r i a l D i s t r i b u t o r s and Their P r o d u c t i v i t y . (Ohio State U n i v e r s i t y , 1959); R. D. B u z z e l l , " P r o d u c t i v i t y i n Marketing". (Unpublished doctoral d i s s e r t a t i o n , U n i v e r s i t y o f Ohio, 1957).  k proper perspective with which one may view the l e v e l of the pharmaceutical marketing costs.  F i n a l l y , the effectiveness with which the pharmaceutical  firms u t i l i z e t h e i r marketing resources i s determined through the r a t i o of each firm's rate of return to the l e v e l of i t s marketing costs. Chapter V presents both a normative and a descriptive approach to the determination of p r o d u c t i v i t y measures f o r a firm's marketing  department.  F i n a l l y , Chapter VI presents a comparison o f the consistency of the firm's ranked position regarding the effectiveness of i t s marketing department as. determined by the methods presented i n Chapters IV and V.  This i s  followed by the conclusions, and the recommendations for further study.  CHAPTER I I THE ECONOMIC ENVIRONMENT OF THE PHARMACEUTICAL INDUSTRY I.  INTRODUCTION  In recent years, considerable c r i t i c i s m has been voiced from many corners across Canada r e l a t i v e to the high costs of doing business within the e t h i c a l pharmaceutical industry.  As pointed out b r i e f l y i n the previous  Chapter, this study i s concerned with an analysis of the marketing cost structure i n t h i s industry so as to inform the reader about the more important conditions p r e v a i l i n g that, i n part, account f o r the existing marketing cost s i t u a t i o n .  This chapter i s concerned with those considerations which,  t h i s writer f e e l s , require analysis f o r the development o f those arguments presented i n subsequent chapters. A.  They are:  The establishment of a c l a s s i f i c a t i o n scheme f o r the pharmaceutical industry as i t i s presently conceived i n Canada.  B.  An analysis o f certain important economic factors that are charact e r i s t i c o f the industry, including:  the nature o f the market  structure, demand, r i s k , p r o f i t , governmental regulation, trade associations, and i n t e r n a l control. II.  CLASSIFICATION OF THE PHARMACEUTICAL INDUSTRY  Products within the pharmaceutical industry have been c l a s s i f i e d either as e t h i c a l products, or as proprietary products.^  The d i s t i n c t i o n between  these two rests l a r g e l y upon the d i r e c t i o n of promotion,^  as shown i n  L_he popular press would normally r e f e r to these products as e t h i c a l drugs and proprietary drugs. This i s a misnomer, as drug refers to the active ingredients within the products or pharmaceuticals. 2Promotion has been defined as any e f f o r t on the part o f the company intended to stimulate company sales through dissemination of information to buyers, p o t e n t i a l buyers, or purchasing agents. J . Howard, Marketing Management. (Homewood, I l l i n o i s : Irwin, 1963) p. 387.  6 I l l u s t r a t i o n 1. Illustration 1 Direction o f Emphasis i n the Promotion of Pharmaceutical Products E t h i c a l Products Prescription Pharmaceuticals manufacturer  J  *  Proprietary Over-the-Counter Pharmaceuticals manufacturer  •  t>  physici-tn- • .>pharmacist  4  physician^pharmacist  Products  consumer  manufacturer : i r e t a i l outlet-^consumer  consumer  d i r e c t i o n of major emphasis  •••> d i r e c t i o n o f minor emphasis  E t h i c a l products are c h a r a c t e r i s t i c a l l y promoted to both p r a c t i s i n g physicians and pharmacists.  Whereas, the other products are promoted  d i r e c t l y to the r e t a i l o u t l e t and/or the ultimate consumer.  Those e t h i c a l  products that are l e g a l l y available only on p r e s c r i p t i o n from physicians are c a l l e d p r e s c r i p t i o n pharmaceuticals.  Such products as " 2 9 2 ' s " ,  "Seconal", and "Phenobarb" f a l l into t h i s category.  On the other hand,  e t h i c a l products that may be purchased without a prescription are c a l l e d over-the-counter (OTC) pharmaceuticals; f o r example, "222's", "Neosynephrine" nose drops, and " C o r i c i d i n " cold t a b l e t s .  Although a con-  sumer may purchase an OTC pharmaceutical without a p r e s c r i p t i o n , i n some cases prescriptions may be issued.  To i l l u s t r a t e : "Auralgan" ear drops are  often regarded as a p r e s c r i p t i o n pharmaceutical, although they are i n f a c t an OTC pharmaceutical.  Although a c l e a r d i s t i n c t i o n has been made between  the two types o f e t h i c a l products, a single pharmaceutical house may manufacture both types.  In f a c t , t h i s i s the usual case.  7 Proprietary products are occasionally referred to as "advertised remedies" or as "patent medicines".  These products are promoted d i r e c t l y to the  r e t a i l o u t l e t and/or ultimate consumer.  The manufacturers of proprietary  products are noted f o r t h e i r large advertising budgets, as well as for t h e i r supplying of generous dealer aids, i n the form of in-store sales promotion, whereas, only dealer aids are used i n the promotion of OTC pharmaceuticals. Certain products,  that are chemically and therapeutically s i m i l a r , may  be promoted by both methods.  For example, a c e t y l s a l i c y l i c acid i s promoted  both as "Empirin Compound", an e t h i c a l OTC pharmaceutical, and as "Bayer's A s p i r i n " , a proprietary product. The above d i s t i n c t i o n s should be noted i n that t h i s study i s concerned with the marketing costs incurred within the e t h i c a l pharmaceutical industry; proprietary products w i l l not be further III. A.  considered.  ECONOMIC FACTORS CHARACTERISTIC TO THE ETHICAL PHARMACEUTICAL INDUSTRY Nature of the Market Structure I t would appear that the nature of the market structure of the e t h i c a l  pharmaceutical industry may  be described as a d i f f e r e n t i a t e d oligopoly.  This i s substantiated by the following analysis. 1.  Size of the  Industry  The s i z e of the e t h i c a l pharmaceutical industry, as  represented  3 by the t o t a l d o l l a r value of factory shipments, i s shown i n Table I. 3Dominion Bureau of S t a t i s t i c s , Manufacturers of Pharmaceuticals and Medicines. (Ottawa:Queen's P r i n t e r s ) , 1953. I960, 1961, 1962, 1963, 1964, I965. The number of establishments includes firms manufacturing both e t h i c a l and proprietary products. The information i s not available to c l a s s i f y these firms into the two product groups, since many i n d i v i d u a l firms manufacture both types of products.  8 TABLE I RELATIONSHIP OF THE NUMBER OF ESTABLISHMENTS AND THE TOTAL VALUE OF FACTORY SHIPMENTS IN THE CANADIAN PHARMACEUTICAL INDUSTRY 1963 i960 I96I 1962 1963 1964 1965 Number o f Establishments 198 217 174 167 161 173 175 Total Value of Factory Ethical 66.3 119.6 120.7 126.6 141.6 151.7 168.2 Shipments ($ m i l l i o n s ) Proprietary 18.6 24 .4 24.6 26.6 24.5 25.2 32.4 At the end o f the twelve year period, the t o t a l value o f factory shipments o f e t h i c a l products had increased by 154 percent.  This may be compared  with a 74 percent increase i n the value o f proprietary products.  The larger  percentage increase i n e t h i c a l products i s mainly the r e s u l t of an increase i n t o t a l demand f o r e t h i c a l pharmaceutical products.  Demand i s analyzed on  page seventeen o f t h i s Chapter. 2.  Degree o f Concentration of S e l l e r s The degree o f concentration within the o v e r a l l pharmaceutical  industry f o r the years 1953 and i960 i s shown i n Table I I . ^ TABLE I I PHARMACEUTICAL ESTABLISHMENTS GROUPED ACCORDING TO THE SIZE OF THE VALUE OF THEIR FACTORY SHIPMENTS 1953 Value o f Factory Number o f S e l l i n g Shipments E s t a b l i s h - Value $(,000) ments $(,000) 188 464  Under $10 10 to 25 25 to 50 50 to 100 100 to 200 200 to 500 500 to 1,000  25 27  5,000 and over  18 4  3,968 7,940 19,613 34,210 24,412  217  93,557  1,000 to 5,000 TOTAL  38 28 21 28 28  729 2,032  9>  of t o t a l Shipments .2  I960 Number o f S e l l i n g Establish- Value ments $(,000)  26.09  9  141 371 717 1,081 3,374 10,565 10,879 70,546 67,224  100.00  198  L64.895  .5  .78  2.17  4.24 8.49 20.96  36.57  29  22 21 15  23 32 16 31  ^ R e s t r i c t i v e Trade Practices Commission, The Manufacture, and Sale o f Drugs. (Ottawa:Queen's P r i n t e r , 1963) p. 54.  i  of t o t a l Shipments .09 .22 .43  .66 2.05  6.4 6.6 42.78 40.77 100.00  Distribution  9 In 1953.  the four l a r g e s t establishments (2 percent of a l l firms)  accounted f o r 26 percent of the industry's t o t a l s e l l i n g value. two l a r g e s t establishments of the s e l l i n g value.  The twenty-  (10 percent of a l l firms) accounted f o r 62 percent  By comparison, i n I960 the nine largest e s t a b l i s h -  ments (5 percent of a l l firms) had kl percent of the industry's t o t a l s e l l i n g value.  The f o r t y l a r g e s t establishments (20 percent of a l l firms) accounted  f o r 82 percent of the s e l l i n g value.  In addition, more recent market surveys  show that no single company holds as much as 6 percent of the Canadian Pharmaceutical market.5  I t i s apparent that the degree of concentration within  the industry i s diminishing. For purposes of t h i s study, only the degree of concentration among e t h i c a l firms i s considered.  This w i l l involve an analysis of the  therapeutic markets^ which together make up the t o t a l sales for the ethical pharmaceutical  industry.  Harley"'' states that within the e t h i c a l pharma-  c e u t i c a l industry there exists a p o s i t i v e relationship between the largest firm's market share and the degree of concentration of s e l l e r s within that industry.  Furthermore, he goes on to say that within the three l a r g e s t  therapeutic markets, a n t i b i o t i c s , hormones, and vitamins and nutrients, no single firm's market share exceeded 21  percent.  Frost, however, argues that a firm's market share i s r e l a t i v e l y unstable, with respect to the cardiovasculars, d i u r e t i c s , and c o r t i c o s % . C. Harley, Drug Costs and P r i c e s . Minutes and Proceedings. Queen's P r i n t e r s , 1966) p. 28?. ^The t o t a l industry market i s composed of twenty-four markets.  7lbid. 1  (Ottawa:  therapeutic  10 teroids.  One can t e n t a t i v e l y conclude that within the therapeutic market  structure, considerable interdependence between firms exists as a r e s u l t of a high degree of concentration (a few number of major firms) and resulting i n s h i f t i n g market shares. 3.  Product D i f f e r e n t i a t i o n Product d i f f e r e n t i a t i o n exists within most therapeutic markets;  that i s , each product i s an imperfect substitute f o r another.  The d i f f e r -  entiation may be based upon variations i n the following product characteristics:  q u a l i t y control, aesthetic properties, mode of action^, packaging,  and/or the degree of side e f f e c t s . Most firms use product d i f f e r e n t i a t i o n i n trying to reduce the high cross e l a s t i c i t y of demand f o r t h e i r products i n each therapeutic market.^ QMr. G. E. Frost; a noted patent attorney, brought out some s i g n i f i c a n t facts about competition i n the pharmaceutical industry when he wrote i n the Spring issue of The Patent. Trademark. Copyright Journal of Research Educat i o n , i n 1963. This was quoted by Harley i n , Drug Costs and P r i c e s . Minutes and Proceedings, p. 287. "The drug industry may be divided into a variety of product categories. ..The t y p i c a l record f o r any p a r t i c u l a r product category i s one of constant churning i n so-called 'dynamic' competition—with dramatic s h i f t s i n market positions as existing drugs are displaced by superior products of r i v a l houses. In cardiovascular preparations, the leading company i n 1951 enjoyed about 19 percent of the market, the leading company i n I960 had about 21 percent of the market, and of the four leading concerns i n 1951 only one was among the four leading concerns i n i 9 6 0 . In the case of d i u r e t i c s , four d i f ferent concerns enjoyed the leading market position i n the 1951-60 period, the concern with the largest sales i n I960 was not among those with s i g n i f i cant sales i n 1951. and the concerns with the l a r g e s t sales i n 1951. 195 and 1953 had no s i g n i f i c a n t sales i n i 9 6 0 . In the corticosteroids, the company that pioneered the f i e l d i n 1950 had only about a quarter of the business i n 195^. and by 1956 i t s products enjoyed l e s s than 5$ of the market." 2  9This r e f e r s to the action of a s p e c i f i c pharmaceutical product within the body i n order to produce the desired pharmacological response. •^This r e f e r s to the undesirable pharmacological response of the body to the s p e c i f i c pharmaceutical product. T h e cross e l a s t i c i t y of demand measures the extent to which various commodities are related to each other. Consider commodities X and Y, the cross e l a s t i c i t y of X with respect to Y equals the percentage change i n the quantity n  11 Substitution of products between some therapeutic markets may occur, but i n such cases the cross e l a s t i c i t y of demand between products w i l l normally be low.  For example, some substitution w i l l occur between the following r e -  l a t e d therapeutic markets:  t r a n q u i l l i z e r s and sedatives; a n t i b i o t i c s and  sulfonamides; and anti-hypertensive and d i u r e t i c s .  However, most therapeutic  product classes are poor substitutes f o r other classes and therefore the cross e l a s t i c i t y of demand between therapeutic markets would approach zero. of X taken, divided by the percentage change i n the p r i c e of Y. may be expressed mathematically by the formula: ^ .  Qxj  This  =  APy/Py When the commodities are substitutes f o r each other, the cross e l a s t i c i t y of demand between them w i l l be p o s i t i v e . The extent to which commodities are substitutes i s shown by the flatness of indifference curves. Perfect subs t i t u t e s w i l l have indifference curves that are downward sloping straight l i n e s . This means that the buyer i s i n d i f f e r e n t as to which commodity i s taken. Since perfect substitutes do not exist, indifference curves f o r commodities which are substitutes w i l l have some degree of convexity to the o r i g i n . This i s shown i n I l l u s t r a t i o n 2. The degree of convexity, of indifference curves, w i l l increase as the commodities become poorer substitutes f o r each other. I l l u s t r a t i o n 3 i l l u s trates the l i m i t e d substitution that w i l l occur between two therapeutic markets, such as t r a n q u i l l i z e r s and sedatives. ILLUSTRATION 2 THE HIGH DEGREE OF SUBSTITUTION BETWEEN PRODUCTS Penicillin  w  g  ILLUSTRATION 3 THE LOW DEGREE OF SUBSTITUTION BETWEEN THERAPEUTIC MARKETS Tranquillizers  M  P e n i c i l l i n "v"  Sedatives  Within the range AB the products of these two therapeutic markets are subs t i t u t e s f o r each other. Above A and below B, the buyer i s no longer w i l l i n g to substitute the product of one market f o r a product of another market. The high cross e l a s t i c i t y of demand between the products p e n i c i l l i n "g" and p e n i c i l l i n v within the same therapeutic market i s i l l u s t r a t e d i n I l l ustration 4. Combination A contains x i of p e n i c i l l i n "v" and y i of p e n i c i l l i n "g", and buyer s a t i s f a c t i o n i s maximized on indifference curve 2. An i n crease i n the p r i c e of p e n i c i l l i n "v" rotates the budget l i n e to the l e f t , resulting i n combination B. This combination contains a reduced quantity of p e n i c i l l i n "v , x2, and an increased quantity of p e n i c i l l i n g " , y2. Buyer s a t i s f a c t i o n w i l l be maximized on indifference curve 1, of lower value. H  M  M  w  4.  Economies o f Scale The cost structure o f the pharmaceutical industry i s such that  there are few noticeable economies o f scale r e a l i z e d i n the  production  process due to: a)  Batch methods of production  are often used, whereby they  12 l i m i t the degree o f economies o f scale that may be attained. b)  There usually i s but a very small physical volume o f output  when to comes to highly potent active ingredients i n many pharmaceutical products.  13 •  ILLUSTRATION k THE HIGH CROSS ELASTICITY OF DEMAND BETWEEN PRODUCTS WITHIN THE SAME THERAPEUTIC MARKET Penicillin g"  ILLUSTRATION 5 THE LOW CROSS ELASTICITY OF DEMAND BETWEEN PRODUCTS IN DIFFERENT THERAPEUTIC MARKETS T r a n q u i l l i z ers  M  P e n i c i l l i n "v"  Sedatives  2  x  '  The low cross e l a s t i c i t y o f demand between products i n d i f f e r e n t therapeutic markets i s i l l u s t r a t e d i n i l l u s t r a t i o n 5. In t h i s case, an i n crease i n the p r i c e o f sedatives r e s u l t s i n decreased quantities taken o f products i n both markets. The demand f o r sedatives w i l l be i n e l a s t i c . This means that with a p r i c e increase, more o f a buyer's income w i l l be spent on sedatives, but the quantity purchased w i l l be reduced. Also, there w i l l be l e s s o f the buyer's income available f o r purchase o f t r a n q u i l l i z e r s , so the quantity purchased w i l l also be reduced. l ^ T h i s i s p a r t i c u l a r l y common where fermentation i s the key phase i n the productive process, as i n the case o f a n t i b i o t i c s and synthetic c o r t i costeroid hormones. l^Some examples o f the minute quantities o f active ingredients i n the f i n a l product are: Dexamethasone 5 mg per tablet, Amenorrheal products have . 0 5 and 50 mg o f each o f t h e i r active ingredients, and Oral contraceptives have 1 and . 0 5 mg. By comparison, the lowest accurate measurable weight on most pharmacists' scales i s approximately 60 mg.  13 c)  The package size contains only a small quantity of the  finished product. However, economies of scale may be r e a l i z e d i n both the marketing and the product development departments of some pharmaceutical firms.  Firms  with an optimum number of products should be able to achieve economies i n t h e i r marketing department, p a r t i c u l a r l y i n the advertising and f i e l d sales elements of t h e i r promotional mix.  These economies would be due to the i n -  creased volume of advertising, and the most e f f i c i e n t a l l o c a t i o n of the salesman's time over t h i s optimum product base.15 t h i s industry there i s an attempt to r e l a t e the amount of medicat i o n required to treat the i l l n e s s to the minimum package s i z e , as i l l u s t r a ted i n the following table. This relationship i s established i n an attempt to achieve a higher therapeutic response to the medication by the prevention of both under and over medication. Therapeutic Class Antibiotics-tablets -liquid Vitamins  Weight Control Oral contraceptives Amenorrheal products  Dosage One tablet four times d a i l y One teaspoonful four times d a i l y One t a b l e t d a i l y or One tablet three times d a i l y One tablet d a i l y One tablet d a i l y One tablet d a i l y  Average length of treatment  Minimum package size  Four days  16  Four days  2 oz. or 16  Monthly repeats allowed rt 30 days 20 days 3 days  tablets  doses 30 tablets 100 tablets 1 month supply 30 tablets 20 tablets 3 tablets  Larger quantity sizes are produced, of course, but with each progressive increase i n package size the degree of r i s k to the pharmacist increases. Often the optimum package size i s reached with either the minimum or one size l a r g e r , since p r e s c r i p t i o n demand f o r a pharmaceutical may be suddenly diminished. In that case, there would be no l e g a l way f o r the pharmacist to reduce h i s now obsolete inventory of opened bottles. 15However, diseconomies i n the marketing department w i l l arise from an excess of products. Then the salesman's e f f o r t i s d i l u t e d to the point where no market i s cultivated s u f f i c i e n t l y f o r a high degree of penitration due to excessive product o f f e r i n g s .  Ik The establishment o f an optimum s i z e research and product development department involves a considerable f i n a n c i a l expenditure. Consequently, economies of scale may be r e a l i z e d by firms with few f i n a n c i a l constraints and an o p t i mum product base. 5.  Barriers to Entry There are few b a r r i e r s to entry into the e t h i c a l pharmaceutical  industry when entry i s made on a small scale.  In small scale operations  firms would not establish a research and product development department, nor would i t be l i k e l y that t h e i r marketing operations would be p a r t i c u l a r l y sophisticated, f o r example, many of these firms' promotional programmes could be handed over to wholesalers f o r implementation.-^ However, formidable b a r r i e r s would e x i s t f o r large scale firms desiring to enter the e t h i c a l drug industry. These b a r r i e r s would include: ( l ) the establishment o f a marketing department and a research and development department; (2)  the possession o f patents, trademarks, copyrights,  l i c e n s e s and/or working agreements with other manufacturers; and (3) s t a n t i a l f i n a n c i a l backing.  Most o f these b a r r i e r s may be breached  subthrough  the purchase o f an established firm,^? or by the spin-off o f a firm with a broad product base.-^ 6.  Non-Price Competitive P r a c t i c e A p o l i c y of non-price competitive p r a c t i c e i s carried on by  many firms within the e t h i c a l pharmaceutical industry. Although small firms that s e l l generic pharmaceutical products secure much o f t h e i r business as l^Most small firms do not have a highly developed sales force. Consequently, most product information and promotional s e l l i n g e f f o r t i s provided by the wholesaler's sales force. B. Shuttleworth was purchased by Pitman-Moore Ltd., a d i v i s i o n o f Dow Chemical L t d . iSSquibb formed Linsom and P f i z e r formed Roerig Labs. L t d .  15 a r e s u l t o f active p r i c e competition, the l a r g e r firms, who comprise eightyf i v e percent o f the industry, emphasize non-price  competition.^9  The general industry's feeling r e l a t i v e to non-price competition i s i l l u s t r a t e d by the comments o f Mr. J . A. Bertrand, the Manager o f the Medical Products Department o f Cyanamid o f Canada, Limited.  A member of the  special committee on Drug Costs and P r i c e s asked whether or not a competing product sold at the same p r i c e as t h e i r product.  Mr. Bertrand said:  "I do not know about that. I would be very surprised i f i t did not s e l l f o r approximately the same p r i c e . I think you are getting into an area such as, f o r example, gasoline which various companies tend to s e l l at the same p r i c e . You have a competitive s i t u a t i o n . I do not think we could l i v e too long with a drastic p r i c e d i f f e r e n t i a l between our major a n t i b i o t i c s and the major a n t i b i o t i c s o f other reputable companies. Now, t h i s does not imply, at a l l , i n my f e e l i n g , that there i s any collusion or a conspiracy to keep prices at a certain l e v e l . This i s p a r t o f the competitive l i f e o f the economy. I f we have p r i c e reductions i t puts the other company under pressure to determine whether they can continue to s e l l t h e i r products, or whether they would be better advised to reduce their p r i c e to our l e v e l . " * ' 0  Non-price competition tends to develop because, ( l ) the s e l l e r f e e l s that p r i c e cuts w i l l be met promptly by other competitors, (2)  price  reductions are not e a s i l y reversed, (3) open p r i c e competition often degenerates into uncontrolled p r i c e wars, and (4) the s e l l e r believes h i s demand to be i n e l a s t i c , a l l o f which substantiate the o l i g o p o l i s t i c structure o f this market.  Consequently,  there has been a high degree o f p r i c e s t a b i l i t y within  the e t h i c a l pharmaceutical industry, and new therapeutic products have been priced, for the most part, to compete with older ones within the same l^Most o f the larger e t h i c a l pharmaceutical manufacturers are members of the P.M.A.C. H. C. Harley, Second (Final) Report on Drug Costs and Prices (Ottawa:Queen's P r i n t e r s 1967) p. 9. ^ H a r l e y , Minutes and Proceedings, op. c i t . , p. 66l.  16 market. ^ 2  7.  Competitive R i v a l r y Competitive r i v a l r y tends to be complementary to non-price  competition.  Within the pharmaceutical industry, competitive r i v a l r y mani-  fests i t s e l f i n two major areas. R i v a l r y may take the form of competition i n c r e a t i v i t y , that i s , where consumers and producers a l i k e are caught up i n an almost compulsive session f o r that which i s new.  ob-  In the extreme case, the i n d i v i d u a l firm i s  forced constantly to remould i t s products, to create something new improve an existing product i n terms of performance or design.  and/or to  A p o l i c y of  competitive innovation seems to have been formulated by some i n d i v i d u a l firms and R & D  departments have been established as a vehicle of t h i s  p o l i c y . P r o f i t s may  come to depend on the firm's p o s i t i o n i n the innovation  race, with the cost of an organized and e f f i c i e n t research and development department being regarded as a necessary expense of entering the race.  Once  some firms have taken t h i s p o s i t i o n , others are forced to follow i n order to maintain and protect t h e i r market share. Competitive r i v a l r y i s also evident within the firm's marketing system.  The presence of t h i s r i v a l r y i s indicated by,, ( l ) increased adver-  tising appropriations,  22  (2)  l a r g e r f i e l d sales s t a f f and/or (3)  increased  frequency of c a l l upon prescribing physicians. ^ • R e s t r i c t i v e Trade Practices Commission, op_. c i t . , p. 173 showed the following prices f o r pharmaceutical products within a n t i b i o t i c therapeutic market: 250 mg tablet or capsule (new) CosaAmount Tetrex Declomycin Aureomycin Achromycin Cloromycetin tetracyn Albamycin  16's  100's  $  56.60  $ 9.^4  56.61  $ 9.kk  56.61  $ 9.kk 56.61  $ 9.^5 56.70  $ 9.^ 56.61  $ 9.^3 56.62  op " A detailed analysis i s undertaken of six i n d i v i d u a l firm's advertising expenditures i n Chapter h under "Promotion P o l i c y " pg. 58.  17 In summary, the e t h i c a l pharmaceutical competitive a)  industry has the following  characteristics: A degree of concentration among the larger s e l l e r s causing interdependency of action.  b)  Product d i f f e r e n t i a t i o n within most therapeutic markets.  c)  Economies o f scale i n the marketing and R & D  d)  Formidable b a r r i e r s to entry f o r large-scale firms.  e)  The presence of non-price competition and competitive  Consequently, i t may be stated that the pharmaceutical  departments.  rivalry.  industry has a  d i f f e r e n t i a t e d o l o g o p o l i s t i c market structure. B.  Demand Analysis An analysis o f demand within the pharmaceutical  an investigation o f demand i n terms of:  industry involves  the industry, the therapeutic  market segment, and the product's target market. 1.  Industry Demand The industry demand f o r pharmaceutical  primarily by the incidence of i l l n e s s .  products i s influenced  Industry demand i s the t o t a l de-  mand of the twenty-four therapeutic markets which are found i n each o f the four i n s t i t u t i o n a l markets.^3 extent by the promotional  I t cannot be expanded to any appreciable  e f f o r t s o f i n d i v i d u a l firms.  demand may be expanded through:  (1)  However, industry  the development o f new therapeutic  3These markets are: the r e t a i l , h o s p i t a l , other government i n s t i t u tions, e.g. Crease c l i n i c , and government departments, e.g. Dept. o f Veteran's A f f a i r s . Since these markets are separable, thus preventing a r b i trage, and have d i f f e r e n t e l a s t i c i t i e s o f demand, p r i c e discrimination may be practiced. The order of e l a s t i c i t y o f demand between these markets i s : r e t a i l , h o s p i t a l , government i n s t i t u t i o n s and government departments. This i s due to the increased rate o f substitution between competing products. I t i s p r i m a r i l y i n these three l a t t e r markets that generic products have greater acceptance. 2  18 markets designed to s a t i s f y l a t e n t demand by p r o v i d i n g treatment f o r prev i o u s l y untreatable medical cases, and/or (2) the expansion o f t o t a l demand w i t h i n a therapeutic market. 2.  Demand Within the Therapeutic Market Segment The t o t a l demand f o r each o f the twenty-four therapeutic market  segments tends to be r e l a t i v e l y i n e l a s t i c due to the presence o f few subs t i t u t e s , as shown i n footnote 15.  I t may be expanded by new s i g n i f i c a n t  advances i n the treatment o f medical problems. -* 2  3.  Demand Within the Product Target Market ^ 2  The demand w i t h i n the product's t a r g e t market tends to be more e l a s t i c than does the primary demand f o r t h i s therapeutic market segment c l a s s due to the presence o f s u b s t i t u t e s .  Firms attempt to s h i f t and/or  move along t h e i r average revenue curves (demand curves f a c i n g the firm) through the implementation o f t h e i r marketing mix. ? 2  C. P r o f i t and Risk The f i n a n c i a l r i s k to an i n d i v i d u a l pharmaceutical f i r m i s o f a high order, due to the r a p i d rate o f product obsolescence.  This i s substantiated  by the f o l l o w i n g excerpts from the R e s t r i c t i v e Trade P r a c t i c e s Commission Report on the Manufacture. Sale and D i s t r i b u t i o n o f Drugs. The A l b e r t a Government stated, "..New pharmaceutical products are accepted more r a p i d l y and become obsolete j u s t as r a p i d l y . . " ^ 2  *The recent development o f t r a n q u i l l i z e r s and o r a l contraceptives has expanded i n d u s t r y demand by the a d d i t i o n o f two t o t a l l y new therapeutic markets. 5The recent i n t r o d u c t i o n o f g r i s e o f u l v i n represented a major improvement i n the treatment o f fungal i n f e c t i o n s . I t has expanded the demand w i t h i n the a n t i - f u n g a l therapeutic market. 26The product's t a r g e t market r e f e r s to the s e l e c t i o n o f p a r t i c u l a r groups o f customers w i t h s p e c i f i c types o f medical problems to whom the f i r m wishes to appeal. 27Various marketing mixes used by s i x e t h i c a l pharmaceutical firms are analyzed i n Chapter 4. 2 8 R e s t r i c t i v e Trade P r a c t i c e s Commission, op_. c i t . . p. 197. 2/  2  19 A study on the l i f e of pharmaceutical products concluded that, "Our studies substantiate the b e l i e f of many that, as e f f o r t and expenditures f o r pharmaceutical research increase, and as crash promotional programs continue to p u b l i c i z e the results of t h i s expanded research, one can anticipate an even greater annual turnover of p r e s c r i p t i o n products and acceleration i n t h e i r rate of obsolescence." 9 2  Dr. B. Dixon, a consulting economist, wrote i n h i s paper to the Commission that "This compulsion to bring out new products, with the attendant r i s k that the product w i l l not pass the t e s t of the market (either because of inappropriateness or competitive s u p e r i o r i t y ) , d e f i n i t e l y gives the indus t r y a rating of a r i s k industry, (as compared, l e t us say, to an industry which i s producing a small number of r e l a t i v e l y stable products, where the rate o f product improvement or development i s low)."30 Hence, high p r o f i t s would be expected by firms i n the industry to o f f s e t the high incidence of r i s k .  However, since no meaningful quantita-  t i v e measure of r i s k has been established, one would not know what l e v e l of p r o f i t s would be commensurate with the inherent degree of r i s k . Taxation S t a t i s t i c s i n 1963  The  showed that the pharmaceutical industry earned  the seventh highest rate of return (net p r o f i t before taxation) r e l a t i v e to sixty-three other manufacturing i n d u s t r i e s . ^  Further analysis of the  f i n a n c i a l r a t i o s of t h i s high r i s k , high p r o f i t industry w i l l be found i n Chapter 2  4.  9 l b i d . , pp. 202-203.  3°Ibid, p.  367.  3^-Harley, Minutes and Proceedings. oj_. c i t . p. 2667. T  20 D.  Control o f the Pharmaceutical Industry In 1964,  the thirteen l a r g e s t firms i n the e t h i c a l pharmaceutical  indu-  s t r y i n Canada were a l l branches or subsidiaries o f foreign firms, with two exceptions.3  2  A l l thirteen firms had annual sales i n excess of four m i l l i o n  d o l l a r s each, and they were the only ones having sales of that magnitude.33 To date the l a s t Canadian firm has been purchased by an American corporation.^ This overwhelming control of t h i s industry by foreign firms leads to a number of p o l i t i c a l and economic implications, many o f which are beyond the scope o f t h i s t h e s i s .  However, one implication i s that public disclosure o f  these firm's a c t i v i t i e s i s only available i n consolidated f i n a n c i a l statements.  Consequently, the compilation o f wholly Canadian f i n a n c i a l s t a t i s t i c s  would be a very d i f f i c u l t task without the information made available by Canadian government i n q u i r i e s . E.  Regulatory Control o f the Pharmaceutical Industry The regulatory control of the e t h i c a l pharmaceutical  industry i s admini-  stered by the Food and Drug Directorate o f the Department o f National Health and Welfare.  Although i t i s not a regulated industry, i n the technical sense  i t i s subject to a considerable and growing body of governmental controls. The areas o f control include: (1) the d i s t r i b u t i o n of pharmaceutical ( 2 ) q u a l i t y control; ( 3 ) pharmaceutical new pharmaceutical  products;  sampling; (4) the introduction of  products to the market; ( 5 )  the advertising of products;  and (6) other controls necessary to protect the public against unsafe pharmaceutical  products.  3 2 i h e y were Connaught Research Medical Laboratories, a crown corporation and Charles E. Frosst Co. Ltd. 33Harley, Second (Final) Report, op. c i t . , p. 9. 3 ^ C h a r l es E. Frosst Co. Ltd., was purchased by Merck, Sharpe & Dohme o f New York, however, the crown corporation (Connaught Research Medical Laboratories) i s s t i l l active within the industry.  21 As a r e s u l t of the governmental regulations on q u a l i t y control, one would think that there would be a standardization o f a l l chemically s i m i l a r pharmaceuticals on the market.  One would also think that t h e i r  biopharmaceutical  properties35 would be s i m i l a r , within a very narrow range. I f such were the case, physicians would then be able to use unhesitatingly any pharmaceutic a l , generic or branded, that reached the market.  However, as Mr. M. Per-  narowsk_36 pointed out, t h i s assumes that products do comply with s p e c i f i c a tions and they are c l i n i c a l l y e f f e c t i v e .  But the r e s u l t s of his studies  indicate that: " F i r s t l y , not a l l products comply with s p e c i f i c a t i o n s . The evidence f o r t h i s statement i s given, i n part, i n t h i s paper and even more conclusively i n reports issued by the Food and Drug Administration. For example, quite recently, t h i s agency analyzed forty-two thousand pharmaceutical samples and found that 7.6 per cent f a i l e d to comply with pharmacopeial s p e c i f i c a t i o n s . Regulatory agencies do check products but can never hope to check a l l the products on the market. Secondly, a regulatory agency can never guarantee the c l i n i cal effectiveness o f the products tested."37 One of the main reasons why q u a l i t y differences are allowed to e x i s t 3  8  35Biopharmaceutics i s the study of the relationships between some o f the physical and chemical properties of a pharmaceutical product and the b i o l o g i c a l e f f e c t s observed following the administration o f t h i s product. 36Dr. M. Pernarowski i s an associate professor at the Faculty o f Pharmacy at U.B.C., Vancouver, B. C. 37Searl, and Pernarowski, "The Biopharmaceutical Properties o f Solid Dosage Forms: I . An Evaluation of 23 Brands of Phenylbutazone tablets, "The Canadian Medical Association Journal. #96, June 10, 1967. p. 1520. 38The monographs i n the regulating pharmacopeias, provide v i t a l data regarding the q u a l i t y o f pharmaceutical products as f a r as " i n v i t r o " (lab) testing i s concerned. However, they do not include any " i n vivo" ( i n the body) t e s t s , that might also be carried out i n order to guarantee the complete safety and effectiveness of a p a r t i c u l a r product. There i s a r e a l need f o r better s p e c i f i c a t i o n s . As the knowledge of the action o f products i n the body increases, the monographs w i l l include better and more complete specifications. Presently a pharmaceutical product may pass the pharmacopeial s p e c i f i cations, when i t s action within the body may be below what i s considered acceptable. Conversely, a product may not pass the s p e c i f i c a t i o n s when i t s drug response within the body may be s u f f i c i e n t . Consequently, only when s p e c i f i c a t i o n s are upgraded to include both i n vivo and i n v i t r o tests may  22 i s the fact that the Food and Drug Directorate i s underfinanced, understaffed and unable to make s u f f i c i e n t inspections.39 Doubt exists i n the minds of prescribing physicians and dispensing pharmacists when there are q u a l i t y d i f f e r e n t i a l s among pharmaceutical products from which they may choose.^  Consequently, most physicians and  pharmacists have placed t h e i r f a i t h i n the large e t h i c a l pharmaceutical firms to uphold the q u a l i t y standards i n t h e i r "quality brand-name" products.  An  established firm knows that i s greatest asset i s i t s reputation f o r r e l i a b i l i t y of products and information with the medical p r o f e s s i o n . ^ Therefore there i s l i t t l e l i k e l i h o o d that these firms would jeopardize t h e i r reputat i o n by the production of sub-standard products. i t be said that compliance to s p e c i f i c a t i o n s i s synonymous with c l i n i c a l effectiveness. The development of adequate standards i s only h a l f the problem. The other half, as mentioned by Dr. Pernarowski, i s to assure that a l l pharmac e u t i c a l products comply with these standards. In h i s study of twenty-three brands of phenylbutazone tablets, Dr. Pernarowski found that f i v e of the brands (21.7 percent) f a i l e d to comply with pharmacopeial s p e c i f i c a t i o n s , and. that two additional brands were i n doubt. Hence, t h i s implies that seven (or 30.4 percent) of the brands were not equal to the best brands on the market. 39_hi s i s substantiated by the following recommendation of the Harley Committee (Drug Costs and Prices, F i n a l Report, p. 5 3 » ) "That the personnel and f a c i l i t i e s of the Food and Drug Directorate be expanded to make possible the implementation of the recommendations of the Boyd Committee, the H i l l i a r d Committee and t h i s Committee". ^°In the t r a i n i n g of both these professions, considerable emphasis has been placed upon the usage of high q u a l i t y products. Since neither profession i s equipped to do i t s own chemical assay work, t h i s responsib i l i t y has been delegated to the manufacturer. As Dr. Pernarowski pointed out, some firms d i l i g e n t l y f u l f i l l t h i s r e s p o n s i b i l i t y , while others take shortcuts. :  ^ H a r l e y , Minutes and Proceedings, op. c i t . . p. 303«  23 F.  Trade Associations within the Pharmaceutical Industry 1.  The Pharmaceutical Manufacturers Association o f Canada (P.M.A.C.) The Pharmaceutical Manufacturers Association o f Canada, i s a non-  p r o f i t organization founded i n 1914 and incorporated under the Dominion Companies' Act i n 1959*  I t represents fifty-seven companies, engaged i n  manufacturing and marketing e t h i c a l pharmaceutical products.  These companies  account f o r eighty-five percent o f the t o t a l d o l l a r value of e t h i c a l products sold i n Canada, under both brand and/or generic name.**'  2  The p r i n c i p a l aim o f the P.M.A.C. i s to advance the interests o f pharmaceutical manufacturers.  I t s objectives are:  "To promote and encourage the inter-change o f knowledge and ideas f o r the betterment o f the pharmaceutical manufacturing industry and i t s services; To foster mutually constructive and s a t i s f a c t o r y trade r e l a t i o n s and to maintain and improve public r e l a t i o n s ; To co-operate with l e g i s l a t i v e committees, government departments and agencies, medical and pharmaceutical societies, and other bodies i n respect to matters affecting the pharmaceutical manufacturing industry; To promote among the members o f the Association a s p i r i t o f f r i e n d l y co-operation, thereby s t r i v i n g f o r c o r d i a l intra-industry relations."^ Membership i s by election and applicants are required to abide by the Association's: (1) P r i n c i p l e s of Ethics; (2) Code o f Marketing Practice; (3) By-laws; (4) Standards of Manufacture and q u a l i t y control; and (5) other rules and regulations which may be i n force from time to time. The p r i n c i p a l contribution of the P.M.A.C. to this thesis has been the general and s t a t i s t i c a l information contained i n t h e i r b r i e f to the Harley committee on Drug Costs and P r i c e s . ^ H a r l e y , Second (Final) Report, op. c i t . . p. 9. ^3Harley, Minutes and Proceedings, op. c i t . . p. 328. 2  24 2.  The Association o f Canadian Drug Manufacturers (A.C.P.M.) In 1966 the Association o f Canadian Drug Manufacturers had f i f t e e n  member firms.  Their share o f the industry's t o t a l d o l l a r value o f factory  shipments amounted to 10 p e r c e n t . ^ These firms are Canadian owned and operated as opposed to most members o f the P.M.A.C.  The A.C.D.M. i s a voluntary  organization, and i n I966 was i n the process of implementing a Code o f Ethics for t h e i r members. 3.  The Independents The Independents are not organized as a group.  They represent not  more than 5 percent o f the value o f the industry's factory shipments. The Independents are those manufacturers who do not wish to be members o f the f i r s t two groups, or who might not be permitted to be.  The A.C.D.M. and the  Independents have not played any r o l e i n the writing o f t h i s thesis, due to a lack o f s p e c i f i c information on t h e i r a c t i v i t i e s . IV.  SUMMARY  The e t h i c a l pharmaceutical industry was defined as those manufacturers whose product promotion was directed towards physicians and pharmacists. Economic factors c h a r a c t e r i s t i c o f the industry were: ( l ) a d i f f e r e n t i a t e d o l o g o p o l i s t i c market structure; (2) i n e l a s t i c demand; (3) and p r o f i t ; (4) predominant foreign ownership;. (5) t r o l ; and (6) the  high l e v e l s o f r i s k  governmental regulatory con-  the presence o f two formal trade associations, the P.M.A.C. and  A.C.D.M., with the balance o f the manufacturers l o o s e l y grouped together  as the Independents.  The P.M.A.C. exerted considerable influence over i t s  members and i s the dominent group within the ethical pharmaceutical industry. 44Harley, Second (Final) Report, op. c i t . . p. 9. ^However, t h e i r omission i s not f e l t to be serious, as t h e i r combined market share amounted to only 15 percent o f the industry's t o t a l d o l l a r value of factory shipments.  CHAPTER I I I THEORETICAL APPROACH TO THE MEASUREMENT OF MARKETING COSTS I.  INTRODUCTION  In recent years, society as a whole and governments i n p a r t i c u l a r have developed an i n t e r e s t i n the l e v e l o f marketing costs that are incurred within the e t h i c a l pharmaceutical industry.  While unit costs  i n manufacturing are being reduced, marketing costs continue to r i s e .  They  account f o r a large share of the d o l l a r value o f the product as i t moves from production, through the marketing system, to f i n a l consumption. C r i t i c s maintain that these costs are excessive and wasteful, and that a responsible marketer should emphasize cost reduction, since there i s a lack of s a t i s f a c t o r y techniques i n the area o f quantitative evaluation o f marketing e f f i c i e n c y . This Chapter i s concerned with the establishment of the basic theoret i c a l framework of marketing costs, that w i l l involve an understanding of the following areas o f thought: (1)  the d e f i n i t i o n of marketing costs, involving the i d e n t i f i c a t i o n of marketing functions and the costs of performing these functions.  (2)  cost evaluation, involving the d e f i n i t i o n of marketing e f f i c i e n c y and a quantitative method o f measuring  efficiency.  Subsequent Chapters w i l l be b u i l t around t h i s t h e o r e t i c a l framework i n order to analyze the l e v e l and the composition of marketing costs. II.  THE DEFINITION OF MARKETING COSTS  Several approaches^ to defining marketing costs involve the d i v i s i o n of the marketing system into functional areas, so that each area i n turn lThe writer notes that these are not the only three d e f i n i t i o n s of marketing costs, but they were chosen i n order to exemplify the v a r i a t i o n of thought on t h i s subject.  26 i s definable and measurable. A.  J . W.  Culliton  J . W.  C u l l i t o n defined marketing costs as those costs associated with:  ( 1 ) the creation of a sale; (2) the s t i r r i n g up of new design of saleable goods, and  wants; ( 3 ) the  (4) the d e l i v e r y of goods to f i l l e x i s t i n g  wants or to complete a sale already made.  2  He was  concerned with marketing  costs from the viewpoint of managerial control, that i s , C u l l i t o n ' s d e f i n i tion was  intended to help managers ensure that the value received was  in  l i n e with the cost of the outlay. 6.  Staudt and  Taylor  Staudt and Taylor, on the other hand, defined three groups of marketing costs of the basis of the functions performed. getting costs, (2) o r d e r - f i l l i n g costs, and Each cost group was  They were: ( l ) sales  ( 3 ) sales maintenance costs.  further divided into f i x e d and v a r i a b l e costs.  c l a s s i f i c a t i o n system was  This  used so that marketing costs could be adapted  to a modified break-even a n a l y s i s . 3 C.  Robert Buzzell Robert Buzzell used a t h i r d method of defining marketing costs.  In  h i s work on p r o d u c t i v i t y measurements applied to marketing,^ he divided the marketing system into various functions^ so that each function could J . W. C u l l i t o n , The Management of Marketing Costs, (Harvard University: Boston, 1948) p. 9 . 3This permits speculation on the degree of p r o f i t a b i l i t y at any p r i c e l e v e l f o r each product produced. The firm's t o t a l cost curve i s plotted by varying quantities of production. The t o t a l revenue curve f o r each of several possible p r i c e s i s also p l o t t e d for varying quantities of production. The distance between the t o t a l cost curve and the t o t a l revenue curve indicated the l e v e l of p r o f i t attained f o r each quantity produced with each of the various p r i c e s . However, t h i s i s a s t a t i c analysis of the firm's p r o f i t p o s i tion that may give a f a l s e p i c t u r e i f adapted to the r e a l world s i t u a t i o n . 4R. D. B u z z e l l , "Productivity i n Marketing", (Unpublished doctoral d i s s e r t a t i o n . University of Ohio, 1 9 5 7 ) . 5These functions were: buying, s e l l i n g , transportation, storage, standardization and grading, financing, risk-bearing and marketing information. 2  subsequently be analyzed and measured by the development of a unit o f output measure.  The aggregated d o l l a r value of a l l the outputs was then to  be determined by weighing each output i n accordance with i t s quantitative importance.  However, Buzzell found that the functional marketing areas he  defined were not accounting centers and as a r e s u l t cost data were unobtainable.  Additionally, many o f the function's outputs were based upon  d i f f e r e n t quantitative units o f measure, and could not be brought to a common base f o r aggregative purposes.  Consequently, Buzzell redefined  marketing costs into either value contributed or value added and was subsequently able to determine p r o d u c t i v i t y measurements r e l a t i v e to the marketing system.^ D.  D e f i n i t i o n of Marketing Costs Incurred In the Pharmaceutical Industry 1.  D e f i n i t i o n o f the Marketing Functions An e t h i c a l pharmaceutical firm's marketing functions are com-  p r i s e d of those tasks performed within three functional areas! d i s t r i b u t i o n , promotion and administration.7 a)  The D i s t r i b u t i o n Function The scope o f the d i s t r i b u t i o n function performed by an  e t h i c a l pharmaceutical manufacturer includes i t s shipping department and extends to the i n i t i a l buyer who takes ownership o f i t s products.  This  function may include three tasks, depending upon the channels o f d i s t r i b u tion that are used by the i n d i v i d u a l firm. 6 . D. Buzzell, Value Added by I n d u s t r i a l Distributors and Their Productivity. (Ohio State University, 1959) p. 79. Value added and value contributed are defined l a t e r i n t h i s Chapter. 7This unusual c l a s s i f i c a t i o n o f marketing functions i s used s o l e l y i n order to duplicate that c l a s s i f i c a t i o n system used by individual firms and the P.M.A.C. i n t h e i r c o l l e c t i o n and compilation o f s t a t i s t i c a l cost data. Recognition i s given to the f a c t that administration i s normally not considered a functional area. R  28 A l l firms have t h e i r shipping departments perform the task of sorting out and accumulation o f t h e i r products. of:  standardization and grading o f products,  This involves the jobs  storage o f products p r i o r to  shipment and preparation o f the products f o r shipment.  The task of ware-  housing products i n depots and t h e i r subsequent a l l o c a t i o n occurs as a r e s u l t o f the use of d i r e c t channels o f d i s t r i b u t i o n .  This task involves  the same basic jobs that are performed by the firms* shipping departments. The task o f transportation i s performed by f a c i l i t a t i n g agents and involves the physical movement o f the firms* products from t h e i r shipping  depart-  ments to the i n i t i a l buyers. b)  The Promotion Function The promotion function i s normally c l a s s i f i e d into three  activities:  personal s e l l i n g , mass s e l l i n g and sales promotion.  These  methods are used to achieve the following i n t e r r e l a t e d tasks: ( l ) to get attention, (2) to hold interest, (3) to arouse desire, and (4) to obtain action.  Personal s e l l i n g involves d i r e c t face-to-face relationships  between s e l l e r s and p o t e n t i a l customers.  On the other hand, mass s e l l i n g  seeks to communicate ideas or information to large numbers of customers at the same time.  Advertising i s the main form o f mass s e l l i n g ; i t i s any  paid form o f non-personal presentation or promotion o f ideas, goods, or services, by an i d e n t i f i e d sponsor.  Sales promotion a c t i v i t i e s can make  both personal s e l l i n g and mass s e l l i n g more e f f e c t i v e by co-ordinating both e f f o r t s .  They stimulate consumer purchasing  and dealer effectiveness  by means o f shows, exhibitions, demonstrations, samples, materials, and various non-recurrent  point-of-purchase  s e l l i n g e f f o r t s not i n the ordinary  29 routine.^ In t h i s thesis however, the promotional function i s c l a s s i f i e d into s l i g h t l y d i f f e r e n t a c t i v i t i e s . 9 detailmen,  They include: (1) personal s e l l i n g by  (2) mass s e l l i n g by journal advertising and d i r e c t mail, (3) Sales  promotion involving the d i s t r i b u t i o n of samples, and (4) p u b l i c r e l a t i o n s involving those a c t i v i t i e s necessary to acquire a public image or persons l i t y i n the minds of physicians and channel members, for example: the production of medical films, p e r i o d i c a l s and the sponsorship  of symposia and  exhibits. c)  The Administration  Function  The administration function involves the administration of marketing a c t i v i t i e s .  More s p e c i f i c a l l y , i t includes the tasks of manage-  ment and s t a f f services i n the administration of the defined marketing functions plus product and p r i c i n g strategies and market research. 2.  The Measurement of Marketing Costs Marketing costs r e f e r to the expenses incurred by a firm i n the  performance of i t s marketing functions.  An expense i s the expired cost of  the flow, into the market, of goods or services that are d i r e c t l y or i n d i r e c t l y related to the given f i s c a l p e r i o d . ^  As a r e s u l t of t h i s time con-  s t r a i n t two types of expenses (costs) are incurred:  outlay costs and book  costs. J . McCarthy, Basic Marketing. (Richard Irwin:Homewood I l l i n o i s ,  1964) pp. 640-646.  9This c l a s s i f i c a t i o n p a r a l l e l s that system used by firms and the P.M.A.C. i n the c o l l e c t i o n of t h e i r s t a t i s t i c a l cost data. I t would be more usual f o r p u b l i c r e l a t i o n s to be considered under a separate department. l ^ E . S. Hendriksen, Accounting Theory. (R. D. Irwin, Inc.:Homewood, I l l i n o i s , 1965) p. 143.  30 a)  Outlay Cost An outlay cost refers to those costs that are represented  an expenditure of cash or a transfer of p r o p e r t y . ^  by  They are o b j e c t i v e l y  determined and are usually d e f i n i t e i n t h e i r amount. b)  Book Cost Book costs commonly r e f e r to depreciation costs and comprise  the difference between the net value at which an asset appears on the books of account, as d i s t i n c t from the asset's market or i n t r i n s i c  value.^  2  Depreciation expense i s incurred when the economic l i f e of the goods extends beyond the given time period, and i t r e f e r s to the estimated cost of the expired usefullness of the goods (assets) within the given time period.  The  book entries, as opposed to cash payments, of the depreciation expense are based upon the application of depreciation rates to assets.  Depreciation  expense may not be d e f i n i t e i n amount, due to the v a r i a t i o n i n the methods of determining the rate of depreciation, nor may  they be as o b j e c t i v e l y  determined due to the d i f f e r e n t methods of asset valuation to which the depreciation rates are applied. Various methods have been suggested f o r determining the rate of depreciation to be applied to a given asset.  However, only the  declining balance method i s acceptable i n Canada f o r income tax purposes. Nevertheless,  other methods may be used i n the preparation of a firm's  f i n a n c i a l statements i f they are to be used f o r other than income tax purposes.  Consequently i n any cost comparison the analyst should endeavour  l ^ E . L. Kohler, A Dictionary f o r Accountants. (Prentice-Hall: Englewood C l i f f s , N. J . 1963) p. 349.  12ibid.. p. 71.  31  to establish what methods have been used for determining the rate of deprec i a t i o n , i n order for these expenses to have greater meaning. Depreciation expenses may  not be as o b j e c t i v e l y determined  as outlay costs, due to the d i f f e r e n t methods of asset valuation to which the depreciation rates are applied.  As a r e s u l t , s i m i l a r assets may  vary  widely, from firm to firm, i n t h e i r magnitude that i s shown i n the firms* f i n a n c i a l statements.  Hence, an analyst must be aware of these methods of  asset valuation i f he i s concerned with the comparability of figures between firms.  The methods of asset valuation include:  economic l i f e .  h i s t o r i c a l cost, and current cost. (1)  Economic Value as a Basis of Valuation Economic value i s defined as the present value of an  asset's expected future receipts.13  Accountants have rejected economic  value as the basis of asset valuation and income determination ing  i n account-  on the strength of the following arguments.-^ (a)  A f u l l y detailed statement of a firm's assets  would require the valuation of each asset taken by i t s e l f .  For the most  part, a firm's assets derive t h e i r value from t h e i r place as part of an integrated whole.  Taken by i t s e l f , any one such asset has l i t t l e or no  value, and the future receipts i t would produce are n e g l i g i b l e . (b)  The economic concept of income includes a l l value  changes, whether r e a l i z e d or unrealized.  That i s , income i s not  recognized  at the time of production or of sale, but rather at either the time the 13Gordon and S h i l l i n g l a w , Accounting A Management Approach. (Richard Irwin, Inc.:Hornewood, I l l i n o i s , 1 9 6 4 ) , p. 265.  l ^ i b i d . . pp. 252-256.  32 asset i s purchased, or at the time the firm recognizes a change i n the future receipts the asset w i l l produce. be c l a s s i f i e d i n any meaningful (c)  Income defined i n this way  way.  The accountant cannot meaningfully  basis of valuation i n any objective way.  A firm's owners or  and creditors make investment and disinvestment  implement t h i s stockholders  decisions on the basis of  t h e i r judgment as to the future consequences of t h e i r actions. ment i s improved by the provision of objective accounting (2)  cannot  This judg-  data.  H i s t o r i c a l Cost as a Basis of Valuation H i s t o r i c a l cost or acquisition cost represents the cost  to the firm at the time of the acquisition of goods or services. a l l outlays necessary to render an asset suitable f o r i t s intended should be treated as elements of the asset's cost.  That i s , use  The h i s t o r i c a l cost  basis of valuation rests on the assumption that h i s t o r i c a l cost or depreciated cost i s a v a l i d and workable quantitative measure of economic activity.^5  The acceptance of t h i s basis of valuation i s founded on the  following reasons. (a)  I f the business i s not i n fact going to be sold,  there i s no point i n valuing the assets at what they could be sold for (current market values). (b)  Valuing assets at t h e i r purchase p r i c e i s a more  d e f i n i t e and certain basis than the alternative of attempting to estimate current market values. !5E.  L. Kohler, op_. c_t., p. 147. N. Anthony, Management Accounting. Text and Cases. (Richard Irwin, Inc.,:Homewood I l l i n o i s , I960) p. 32.  33 (c)  I f the accountant based h i s figures on current  market values, he would be obliged to keep track of the ups and downs of market p r i c e s , which would add to the complexity of h i s task. (3)  Current Cost as a Basis of Evaluation Current cost i s h i s t o r i c a l cost restated i n terms of  current p r i c e s .  That i s , the cost of the items making up a firm's balance  sheet or income statement i s expressed at present day p r i c e l e v e l s . may  be accomplished  This  by:^ (a)  applying to the h i s t o r i c a l cost the  appropriate  index numbers (adjusted h i s t o r i c a l cost) or by (b)  substituting f o r h i s t o r i c a l p r i c e s currently  p r e v a i l i n g p r i c e s of equivalent goods and services (replacement c o s t ) . The use of t h i s method of valuation has gained considerable support i n recent years within the United States.  However, the issue  of current cost versus h i s t o r i c a l cost valuation i s beyond the scope of this thesis.  I t i s presented to enlarge the background against which  present-day accounting  methods of valuation are viewed.  The f i n a n c i a l data shown i n Appendix I was not presented i n s u f f i c i e n t d e t a i l to i d e n t i f y the method of asset valuation and the method of calcul a t i n g the rate of depreciation.  H i s t o r i c a l cost i s the most probable  basis of asset valuation used by firms i n the preparation of t h e i r f i n a n c i a l statements.  However, i t has been necessary to assume that the basis for  calculating the rate of depreciation i s s i m i l a r for a l l firms with the r e s u l t that the depreciation expense i s a comparable figure. In an analysis and comparison of costs, many d i f f e r e n t types of costs w i l l be encountered and as a r e s u l t i t i s important to be f a m i l i a r with !7E.  L. Kohler, op_. c i t . . p.  154.  34 them and t h e i r distinguishing features. The actual cost figures used i n subsequent chapters were obtained i n b r i e f s presented to the Harley Committee on Drug Costs and Prices i n  1966,  and i t i s assumed that these b r i e f s contain the best possible available information. III.  COST EVALUATION  In t h e i r reply to the c r i t i c i s m directed towards t h e i r marketing costs, management has had to r e l y p r i m a r i l y upon a subjective rebuttal, due to the lack of s a t i s f a c t o r y techniques i n the area of quantitative evaluation of marketing e f f i c i e n c y . Financial accounting  r a t i o s have been used extensively  i n an attempt to evaluate and compare the pharmaceutical marketing i n s t i t u tions with other segments of the business community.^9  However, the f a c t  that management's response has been weak i s well i l l u s t r a t e d by numerous governmental probes 0 into matters which previously were only the concern 2  of the business community.  One may  only expect greater governmental i n t e r -  A comparison of the types of costs and the basis of t h e i r d i f f e r e n t i a t i o n i s shown i n the table below. C l a s s i f i c a t i o n of Cost Distinctions Dichotomy Basis of D i s t i n c t i o n opportunity cost outlay cost nature of the s a c r i f i c e past cost future cost degree of anticipation short-run cost degree of adaptation to present long-run cost outlay variable cost constant cost degree of v a r i a t i o n with output rate traceable cost common cost t r a c e a b i l i t y to unit of operations out-of-pocket cost book cost immediacy of expenditure incremental cost sunk cost r e l a t i o n to added a c t i v i t y escapable cost unavoidable cost r e l a t i o n to entrenchment controllable cost uncontrollable cost c o n t r o l l a b i l i t y Source; J . Dean. Managerial Economics. (Prentice-Hall:Englewood Cliffs. New Jersey, 1951) p. 271. !9H. C. Harley, Drug Costs and P r i c e s . Minutes of Proceedings and Evidence (Queen's Printers:Ottawa, 1966) pp. 695-703; 2301-2404. 20The Special Committee of the House of Commons on Drug Costs and P r i c e s , 1966; the Royal Commission of Health Services, 1964; The Report of the R e s t r i c t i v e Trade Practices Commission on the Manufacture, D i s t r i b u t i o n and Sale of Drugs, 1963; The Royal Commission on Patents, Copyright and I n d u s t r i a l Design, I960; A report on the R e t a i l Structure of Drug Prices i n Manitoba, 1961; A Report on Dispensing Costs i n B.C., 1965; and The Report of the Select Committee of the Ontario Legislature on the Cost of Drugs, 1963. x o  35 ventions i n the future, unless measures o f productivity and e f f i c i e n c y o f the marketing system are developed.  These measures could then be compared  with previously established standards, i n order to arrive at an e f f i c i e n c y rating o f numerous marketing systems.  Hopefully, the l e s s e f f i c i e n t systems  would subsequently undergo a r e - a l l o c a t i o n o f t h e i r resources i n an attempt to become more e f f i c i e n t .  However, a standardized d e f i n i t i o n o f e f f i c i e n c y  must be established i n order f o r the r e s u l t s to be meaningful. A.  D e f i n i t i o n o f Marketing E f f i c i e n c y The d e f i n i t i o n o f marketing e f f i c i e n c y that w i l l be used i n t h i s thesis  i s based upon p r o d u c t i v i t y measures. output to marketing input,  P r o d u c t i v i t y i s the r a t i o o f marketing  and i t s subsequent comparison to an accepted  standard r e s u l t s i n the determination o f marketing  efficiency.  Ideally, t h i s standard f o r comparison should r e f l e c t the l e v e l of marketing p r o d u c t i v i t y that i s optimal, but i n the r e a l world an optimal state i s not r e a l i s t i c .  Hence, the e f f i c i e n c y o f a firm's marketing depart-  ment i s judged by comparing i t s p r o d u c t i v i t y measure with a s i m i l a r l y determined p r o d u c t i v i t y measure o f another firm or firms. Often industry averages are considered to be the standard f o r comparison,  and a firm with higher  r e l a t i v e p r o d u c t i v i t y measures w i l l have a higher r a t i o of outputs to inputs and w i l l be judged to be more e f f i c i e n t . B.  T r a d i t i o n a l Methods o f Evaluating E f f i c i e n c y The t r a d i t i o n a l methods o f evaluating a firm's e f f i c i e n c y have involved  the use o f f i n a n c i a l accounting r a t i o s and/or a subjective evaluation o f the firm's e f f i c i e n c y . 1.  F i n a n c i a l Accounting Ratios Some o f the more common f i n a n c i a l accounting r a t i o s used i n the  36 evaluation of marketing performance are: and sales per employee.  inventory and capital turnover;  Each of these r a t i o s involves a comparison of sales  volume with a d i f f e r e n t type of resource input.  Sales volume, however, i s  not a good measure of output, as firms may make d i f f e r e n t economic c o n t r i butions r e l a t i v e to t h e i r sales. Since f i n a n c i a l accounting r a t i o s do not involve a r a t i o of output 21 to input,  they do not measure p r o d u c t i v i t y and as a r e s u l t they cannot be  used to measure a firm's e f f i c i e n c y .  However i n the absence of productivity  measures, f i n a n c i a l r a t i o s serve as proxi variables i n the evaluation of the strengths and weaknesses of firms or industries.  The prevalence of t h e i r  usage arises from the ease with which they may be calculated and compared with previously calculated f i n a n c i a l r a t i o s that represent the a c t i v i t i e s of other firms or industries within the same i n s t i t u t i o n a l a r e a . c i a l r a t i o s may  2 2  Finan-  also serve as a useful supplement to the use of productiv-  i t y measures, as they help to explain variations between p r o d u c t i v i t y measures i n comparable firms or industries.  However, f i n a n c i a l r a t i o s  cannot be considered as equivalent or alternate to p r o d u c t i v i t y measures in the determination of a firm's e f f i c i e n c y .  A p a r t i a l f i n a n c i a l analysis  that u t i l i z e s f i n a n c i a l r a t i o s i s undertaken i n Chapter 4 i n order to determine the f i n a n c i a l c h a r a c t e r i s t i c s of the e t h i c a l pharmaceutical industry. 2.  Subjective Evaluation of E f f i c i e n c y  A firm's e f f i c i e n c y i s often subjectively evaluated according to 21_he r a t i o s of gross margin to net worth and t o t a l tangible assets approximates that of a p r o d u c t i v i t y measure. However, gross margin should not be considered as the economic output f o r the firm, since i t includes values contributed by others external to the firm under study. T h e Ratios of Manufacturers", Dun's Review. V o l . 9 0 , #5, Nov. 67, pp. 7 8 - 7 9 ; "The Ratios of Wholesalers", I b i d . #4, Oct. ' 6 7 , pp. 8 8 - 8 9 ; "The Ratios of R e t a i l e r s " , I b i d . . #6, Dec. ' 6 7 . 22,,  37 The degree of implementation of the following c r i t e r i a : a) b) c) d) e) f) g) h)  The The The The The The The The  degree of s p e c i a l i z a t i o n employed. degree of standardization of methods used. use of labour saving devices. presence of e f f e c t i v e organization. provision of opportunity to employees. effects o f the dynamic nature of the marketing degree of competition i n marketing. use of market research.  system.  i ) The presence of organized education and t r a i n i n g . The application of these c r i t e r i a to firms does not measure e f f i c i e n c y , nevertheless, this c r i t e r i a i s useful. They provide management with a subjective evaluation of:  (1)  the state of technology within the  firm, (2) the degree of motivation of employees, and (3) the v i a b i l i t y of the firm within a dynamic environment.  This evaluation i s based on  the assumption that firms with a p o s i t i v e response to each c r i t e r i o n would be more e f f i c i e n t i n t h e i r operations than firms with a negative response. Hence, the application of this subjective evaluation to firms may o f f e r an explanation f o r the v a r i a t i o n i n p r o d u c t i v i t y measures between comparable firms or industries. criteria,  As a r e s u l t , the subjective application of these  without bias, may serve as a useful adjunct to p r o d u c t i v i t y  measures. C.  The Determination of Productivity Measures Applicable to Marketing P r o d u c t i v i t y measures are based on two premises: (1)  marketing a c t i -  v i t i e s are productive, and (2) marketing i n s t i t u t i o n s make a contribution to the economy just as important and as necessary as those contributions resulting from manufacturing a c t i v i t i e s .  However, the v a l i d i t y of these  premises has been challenged because the r e s u l t s o f many marketing a c t i v i t i e s are of an intangible nature and therefore are thought to be non-productive. The productive nature of the marketing system may be substantiated by  38 the following argument.  In manufacturing, the term value added i s used i n  the same sense as value created or value produced. current economic thinking, values.  This i s i n l i n e with  that production i s the creation o f economic  These values are created through the addition o f u t i l i t y , which are  capacities i n goods o r services to s a t i s f y human wants.^ essence o f production.  This i s the  Consequently, whoever adds u t i l i t y i s engaged i n  production. Hence a wholesaler or r e t a i l e r who normally adds place, time and possession u t i l i t y i s as much a producer as i s the processor who changes a product from one form to another.  However, the degree o f productivity  attained by a firm i s dependent upon the e f f i c i e n c y with which management u t i l i z e s the resources at t h e i r command.  Consequently, the basic premises  are v a l i d and the technique of productivity determination may be applied to the marketing system.  I n i t i a l l y , t h i s involves the c l a s s i f i c a t i o n o f  marketing costs into value added and value contributed i n order to determine the firm's economic output which i s the numerator of the productivity ratio. HR. D. Buzzell, Value Added by I n d u s t r i a l Distributors and Their Productivity, op. c i t . Buzzell described four types of u t i l i t y : 1. Form U t i l i t y . Form u t i l i t y i s added i n any extracting, processing or manufacturing operation which converts or transforms scarce resources into increasi n g l y s a t i s f y i n g states. 2. Place U t i l i t y . Place U t i l i t y i s added when a product or service i s made available where the customer wants i t . For t h i s purpose, goods must be transferred from where they are f i r s t available to the next l o c a t i o n , and so on, u n t i l they reach t h e i r f i n a l destination. 3. Time U t i l i t y . Time u t i l i t y i s added when the product or service i s made available to the customer when he desires i t . k. Possession U t i l i t y . Possession u t i l i t y i s added when the product or service i s at the user's command, that i s , i n h i s possession l e g a l l y and p h y s i c a l l y as through the transfer of t i t l e o f goods.  39 1.  Value Added Concept The technique of p r o d u c t i v i t y measurement i s based upon the value  added concept.  I t i s not a new  concept, for i t has been used by the Dominion  Buteau of S t a t i s t i c s f o r years i n the c a l c u l a t i o n of  "net production"  or  Gross Domestic Product f o r primary, manufacturing and construction industries. However, only recently has t h i s concept been applied to the marketing system by Professor T. Beckman, of Ohio University.  Dr. R. D. Buzzell, a former  student of Beckman's, wrote h i s doctoral d i s s e r t a t i o n on the use of the value added concept i n the determination of marketing p r o d u c t i v i t y . ^  2  Value added i s defined as that part of a firm's net revenue which pays for the performance of i t s marketing functions and services.  That i s ,  value added i s the firm's net revenue minus ( l ) the t o t a l cost of goods sold and (2) the value of the goods and services contributed.  However, when the  p r o d u c t i v i t y of a firm's marketing department i s being determined, the value added may  or may  not include the p r o f i t .  Value contributed i s the cost of the goods and services purchased by the firm from external sources,  f o r use within the firm's marketing  system i n the performance of i t s functions.  I t i s subtracted from the gross  p r o f i t i n order to arrive at the value added and p r o f i t f i g u r e .  This pre-  vents uncontrollable variations i n the size of a firm's value added figure, and subsequent p r o d u c t i v i t y measures. just as was  Value contributed i s also deducted,  the cost of goods sold, to prevent gross duplication i n the  measurement of value created.  A firm's value added becomes the residual  after the value contributed has been removed from the gross p r o f i t , and i t normally includes the firm's p r o f i t including income taxes. 12  R.  D. Buzzell, "Productivity i n Marketing", op_. c i t .  I f the firm  40 can be c l a s s i f i e d as a marketing  i n t e r m e d i a r y ^ then the p r o f i t i s assumed  to r e s u l t p r i m a r i l y from the performance of i t s marketing the value added w i l l include the p r o f i t figure.  a c t i v i t i e s , and  Otherwise the value added  w i l l not include the p r o f i t . The advantages of using the value added as a measure of economic output are fourfold. a)  Value added i s the best reasonably available absolute measure  of the value created i n the process of whatever part of the economy i s measured.  I t measures, without any duplication, what the process i n question  has a c t u a l l y added to a firm i n terms of the enhanced value of goods and services. A firm's value added may be aggregated value added.  to determine the industry's  S i m i l a r l y , the industry's value added may be aggregated to  a r r i v e at the nation's absolute measure of value created. b)  Value added i s the best reasonably available r e l a t i v e measure  of the value created, that can be used f o r proper and f a i r l y accurate comparisons with anything else s i m i l a r l y measured. c)  The subsequent use of the value added figure i n p r o d u c t i v i t y  measurements permits the firm to look at i t s input costs i n t h e i r proper perspective.  That i s i n d i v i d u a l input costs may be compared to the t o t a l  output of the enterprise. To look at costs by themselves without regard f o r the t o t a l output i s not l o g i c a l and may i n fact lead to f a u l t y conclusions. d)  F i n a l l y , the calculation of the value added measure should  r e s u l t i n improved public r e l a t i o n s as the tendency would then be to s h i f t emphasis from costs and wastes to value added or economic output; that i s  13This includes r e t a i l e r s , wholesalers, manufacturer's petroleum bulk plants and agent intermediaries.  sales branches,  41 from a negative to a p o s i t i v e and constructive approach. I t should not be concluded that the value added approach implies that increases i n value added are desirable per se.  From a measurement  point of view, value added consists of a firm's operating expenses, l e s s value contributed, and i n most instances include i t ' s operating p r o f i t . Thus i t might be objected that an i n e f f i c i e n t firm with higher operating expenses would have a higher value added, and that c a l l i n g such expenses value might encourage increases i n expenses.  This i s not so for two  14 reasons. ^ F i r s t , competitive pressures prevent increases i n expense apart from those j u s t i f i e d by increased service or by i n f l a t i o n .  That i s , under  a competitive system, firms have a strong incentive to hold expenses at a minimum, and as a r e s u l t i t may be assumed that the expenses are proportionate to the functions and services they perform.^5 Secondly, value added i s not inconsistent with cost reduction through greater e f f i c i e n c y .  The important thing i s not necessarily the  r a t i o of value added to the net sales, but rather the t o t a l d o l l a r amount of value added.  I f operating expenses can be reduced (and inturn reduce the  amount of value added) and sales increase s u b s t a n t i a l l y as a result,  the  t o t a l value added i n d o l l a r s w i l l increase rather than decline. 2.  The P r o d u c t i v i t y Ratio P r o d u c t i v i t y i s the r a t i o of an economic output to the  correspon-  ding economic input during a given period of time. l^R. D. Buzzell, Value Added by I n d u s t r i a l Distributors and Their Productivity, op. c i t . 15lt i s recognized that competition works imperfectly, and that s l i g h t differences could a r i s e apart from differences i n the services rendered. This i s regarded to be exceptional, rather than t y p i c a l .  42 The economic output refers to the results of productive a c t i v i t y , whether i n the form of physical goods or functions and services, or some combination of the two.  As has been stated, the best single reasonably  available absolute measure of output i s the value added i n d o l l a r s .  If  comparisons were to be made with value added measures over a period of time, i t would be necessary to adjust them by the appropriate p r i c e index i n order to eliminate the effects of p r i c e l e v e l changes. The economic input refers to the factors of production used i n producing the output, that i s , labour, c a p i t a l , land and management.  R. D.  Buzzell used the following input measures i n his study of i n d u s t r i a l d i s tributors:  man-hours of labour, d o l l a r value of t o t a l assets,  d o l l a r value of the net w o r t h . ^  and the  Factors that govern which imput measures  should be used are ( l ) the type of industry to be analyzed, (2) the character of the functions and services performed, relevant data.  and (3) the a v a i l a b i l i t y of the  Only three input measures w i l l be used i n t h i s study of  pharmaceutical firms i n Chapter Five due to the u n a v a i l a b i l i t y of pertinent data.  These measures w i l l be:  man-hours of labour, d o l l a r value of t o t a l  assets, and the d o l l a r value of the inventory put into the marketing system. Ideally, measurements of each of the factors of production should be used and combined into an o v e r - a l l measure of the t o t a l factor productivity. Unfortunately, t h i s i s not possible with the measurement methods developed thus f a r , due to the lack of relevant quantitative data and the absence of a common unit of input measurement. There are certain d i f f i c u l t i e s that one encounters i n the determination of p r o d u c t i v i t y measures. l6  R.  D. Buzzell, I b i d . . p. 78.  43 a)  I t i s d i f f i c u l t to obtain s u f f i c i e n t relevant units of measure-  ment for both inputs and outputs. b)  There i s a lack of s t a b i l i t y f o r the measurements, due  changes i n the general p r i c e l e v e l .  However, t h i s may  to  be compensated for  through the use of p r i c e indexes. c)  The q u a l i t y of the output generally increases over time, and  productivity measures do not take t h i s into consideration.  In t h i s respect  they tend to understate the actual gain i n productivity. d)  There i s an i n t e r - r e l a t i o n s h i p of some of the marketing func-  tions with those of manufacturing.  That i s , some functions may  ferred from one area to another, f o r example, packaging.  be  trans-  This i s p r i m a r i l y  a d e f i n i t i o n a l problem and should not be insurmountable. The benefits r e a l i z e d by the firm from the calculation of i t s productivity measures are twofold. F i r s t , productivity measures can be used to determine trends i n the e f f i c i e n c y of a firm.  They provide a bench mark against which future  years* r e s u l t s can be evaluated. (1)  the competitive structure, (2)  As a r e s u l t , the effects of changes i n , supplier's p o l i c i e s , or (3)  other economic  variables, should be discernible i n the corresponding changes of the  firm's  productivity measures. Secondly, productivity measures can be used to determine e f f i ciencies not only within a firm,  but also between firms and  industries.  Consequently, management can determine the e f f i c i e n c y of i t s marketing system r e l a t i v e to that of i t s competition or to that of another industry. However, i n order f o r these r e l a t i v e e f f i c i e n c y measurements to be v a l i d and correct, t h e i r c a l c u l a t i o n must be based upon s i m i l a r l y determined productiv i t y measures.  These measures w i l l be determined and interpreted f o r six  44 i n d i v i d u a l pharmaceutical  firms i n Chapter Five. VI.  SUMMARY  The d e f i n i t i o n of marketing costs involves the p r i o r i d e n t i f i c a t i o n of the marketing functions.  Within the pharmaceutical  were d i s t r i b u t i o n , promotion and administration.  industry these functions  Marketing costs comprise  both the outlay and book costs of performing these functions.  In order to  assure that the book costs between various firms are comparable, the analyst must be f a m i l i a r with the method used by the firms as a basis for t h e i r asset valuation as well as the method used to a r r i v e at the depreciation expense. Marketing e f f i c i e n c y involves the comparison of marketing p r o d u c t i v i t y measures to an acceptable standard.  The t r a d i t i o n a l methods of evaluating  e f f i c i e n c y include the use of f i n a n c i a l accounting r a t i o s and a subjective evaluation of the degree of implementation of certain c r i t e r i a by the firm(s) under study.  Neither method measures e f f i c i e n c y , however, they may  serve as  useful supplements by t h e i r explanation of variations i n e f f i c i e n c y measures between firms. P r o d u c t i v i t y measures are calculated from the r a t i o of the economic output to the economic input.  The economic output f o r a firm's marketing  department may best be determined through the use of the value added concept. The economic inputs that w i l l be used i n t h i s study include the man-hours of labour and the d o l l a r value of t o t a l assets and the d o l l a r value of the inventory put into the marketing system.  As the d i r e c t r e s u l t of the c a l c u l a t i o n  of p r o d u c t i v i t y measures for a firm's marketing department, a firm w i l l be able to determine i t s marketing e f f i c i e n c y by the comparison of s i m i l a r l y determined p r o d u c t i v i t y measures with other firms or industry averages. w i l l provide a new perspective i n the management of marketing costs.  This  CHAPTER IV ANALYSIS OF THE MARKETING COSTS INCURRED WITHIN THE ETHICAL PHARMACEUTICAL INDUSTRY I.  INTRODUCTION  In 1964, the H a l l Commission recommended that f o r income tax purposes the deductible allowance for pharmaceutical marketing costs should be l i m i t e d to 15 percent o f t o t a l sales.-'-  I m p l i c i t i n t h i s recommendation i s the state-  ment that these costs are excessive and need regulation i n order to give the consumer maximum value.  The v a l i d i t y o f t h i s implication i s not j u s t i f i e d  by ascertaining the l e v e l o f marketing costs alone; rather, one must consider the effectiveness with which marketing funds are employed.  I t i s with this  thought i n mind that t h i s chapter i s written. I n i t i a l l y , the f i n a n c i a l c h a r a c t e r i s t i c s o f the pharmaceutical industry are determined i n order to i s o l a t e the constraints on the implementation of marketing p o l i c i e s .  This i s undertaken by means o f a f i n a n c i a l analysis  involving the comparison of f i n a n c i a l r a t i o s f o r numerous i n d u s t r i e s . Subsequently, the l e v e l of the pharmaceutical marketing e f f o r t i s i d e n t i f i e d as a percentage of sales, and then divided into i t s component parts. The parts, to be defined below, are related to the firm's marketing policies. In order to provide the proper perspective with which one should view the l e v e l o f these costs, the writer introduces the l e v e l o f marketing costs incurred by firms i n other industries to serve as a basis for comparison. F i n a l l y , an attempt i s undertaken to evaluate the effectiveness with which the pharmaceutical firms u t i l i z e t h e i r marketing e f f o r t s .  A ranked  order of effectiveness i s established f o r the firms and related to d i s t i n c 1H. C. Harley, Drug Costs and P r i c e s . Second (Final) Report. (Queen's Printers:Ottawa, 196?) p. 60.  46 t i v e marketing p o l i c i e s . II. A.  FINANCIAL CHARACTERISTICS OF THE PHARMACEUTICAL INDUSTRY  Introduction Since the f i n a n c i a l c h a r a c t e r i s t i c s of any i n d u s t r y act as c o n s t r a i n t s  to the marketing executive operating w i t h i n an industry, proper i d e n t i f i c a t i o n o f these c h a r a c t e r i s t i c s becomes important.  These data are determined  through f i n a n c i a l analyses, i n v o l v i n g the c a l c u l a t i o n and i n t e r p r e t a t i o n of c e r t a i n r e l a t i o n s h i p s that give i n d i c a t i o n s o f r e l a t i v e strength and weakness o f a f i r m or o f i t s industry.  In an e f f o r t to i d e n t i f y the f i n a n c i a l  c h a r a c t e r i s t i c s o f the pharmaceutical i n d u s t r y i n Canada, the w r i t e r has presented, based upon data supplied by the Harley Committee^, a comparison of selected f i n a n c i a l r a t i o s between f i f t y - o n e Canadian i n d u s t r i e s comprising 19,666 f i r m s . i n Table I I I .  manufacturing  This comparison of 1962 data i s shown  A d d i t i o n a l r a t i o s shown i n Table IV are concerned with the  p r o f i t a b l e c h a r a c t e r i s t i c o f the pharmaceutical i n d u s t r y r e l a t i v e to a l l manufacturing i n d u s t r i e s , over a twelve year p e r i o d . C e r t a i n conclusions3 2  have been reached about the f i n a n c i a l c h a r a c t e r i s t i c s o f the pharmaceutical i n d u s t r y by the examination o f r a t i o s shown i n these Tables. ^H. C. Harley, Drug Costs and P r i c e s , Minutes of the Proceedings and Evidence. (Queen's Printer:Ottawa, 1966) pp. 697-703. I b i d . . pp. 348; 600; 698; 824; 833; 942; 1020-21; 1066 and 2402-3. ^ I t i s necessary to i n d i c a t e the l i m i t a t i o n s of these conclusions. Generally accepted accounting p r i n c i p l e s permit some d i s c r e t i o n on the p a r t of accountants i n t h e i r c a l c u l a t i o n of accounting e n t r i e s , upon which f i n a n c i a l r a t i o s are based. The conclusions may be based upon data t h a t are noncomparable. In a d d i t i o n , most o f the conclusions are based upon o n l y one year's data, and hence, g e n e r a l i z a t i o n s regarding subsequent year's a c t i v i t i e s may not be v a l i d . Nevertheless, f i n a n c i a l r a t i o s are used i n t h i s a n a l y s i s as they are e a s i l y c a l c u l a t e d , r e a d i l y understandable, and can serve as general i n d i c a t o r s o f a f i r m or industry's f i n a n c i a l characteristics. 2  47 TABLE I I I COMPARISON OF FINANCIAL RATIOS FOR CANADIAN MANUFACTURING CORPORATIONS IN 1962 The Canadian Pharmaceutical Industry (224 firms i n c l u d i n g e t h i c a l and p r o p r i e t a r y manufacturing Ratio  'h armac e u t i c a l Industry r a t i o  current r a t i o  3.85 times  Ranked order o f the Pharmaceutical Indust r y R e l a t i v e to the F i f t y - o n e I n d u s t r i e s the highest recorded r a t i o  f i x e d assets to net worth  53.3  percent  the 28th highest r a t i o  current debt to net worth  25.6  percent  the 12th  t o t a l debt to net worth  79 percent  sales t o net worth c o l l e c t i o n period  2.47  times  56 days  sales to inventory  5.3  cost o f goods s o l d  49.1  gross margin  50.1 percent  p r o f i t on sales  8.89  p r o f i t on net worth 21.9  lowest r a t i o  the  25th  lowest r a t i o  the  29th  lowest r a t i o  the 11th longest period  times  the 20th highest r a t i o  percent  the 2nd lowest percentage  percent percent  firms)  the 2nd highest percentage the highest recorded percentage the 5th highest percentage  Definitions Current r a t i o ; the current assets are d i v i d e d by the t o t a l current l i a b i l i ties. The current assets are the sum o f cash, accounts r e c e i v a b l e , i n v e n t o r i e s i n c l u d i n g supplies and Government s e c u r i t i e s . Current l i a b i l i t i e s i s the sum o f bank loans, accounts payable, tax l i a b i l i t i e s and amounts due shareholders. Fixed Assets to Net Worth; f i x e d assets are d i v i d e d by the net worth. Fixed assets represent depreciated book values o f b u i l d i n g , l e a s e hold improvements, machinery, f u r n i t u r e , f i x t u r e s , t o o l s , and other p h y s i c a l equipment, p l u s land. Net worth i s obtained by adding preferred and common stock plus surplus. Current Debt to Net Worth; i s derived by d i v i d i n g the current l i a b i l i t i e s by the net worth.  48 T o t a l debt t o net worth: i s obtained by d i v i d i n g t o t a l current debt p l u s mortgage and other funded debt by the net worth. Sales t o net worth: sales are divided by the net worth. C o l l e c t i o n p e r i o d : annual sales are divided by 365 days to obtain the average d a i l y s a l e s , which i s then divided i n t o the t o t a l accounts receivable to f i n d the number o f day's sales t i e d up i n receivables. Sales to Inventory: the annual sales are divided by the inventory. Cost o f goods sold : t h i s includes the c o s t o f inventory which has been sold or used, f r e i g h t o r t r a n s p o r t a t i o n , customs d u t i e s , d i r e c t labour and f a c t o r y overhead. Discounts on purchases are deducted. Gross Margin: t h i s i s derived by deducting the cost o f goods sold from the sales. P r o f i t on Sales: obtained by d i v i d i n g the p r o f i t declared by the companies by t o t a l sales. P r o f i t on net worth: obtained by d i v i d i n g the p r o f i t by the net worth. TABLE 17 COMPARISON OF PROFITABILITY FOR ALL CANADIAN MANUFACTURERS 1953 TO 1964 Rate o f Return on Sales Year  1953 54 55 56 57 58 59 60 61  62 63  Pharmaceutical Industry  9.25 9.08  9.96 10.90 10.59 9.88  10.42 9.24 7.81  7.93 10.05 (PMAC 17.0) 64 9.52 Averaj;e 9.55  A l l Manufacturing Industries 7.48  6.13 7.59 6.10 5.40  5.09 5.53 5.28 5.19 5.47 5.53  Rate o f Return on Invested C a p i t a l Pharmaceutical Industry  16.62 17.63 18.73  21.93 20.47 19.59 23.05 20.55  A l l Manufacturing Industries  Rate o f ileturn on Resources Employed Pharmaceutical Industry  15-03  13.08  13.69 11.68 9.54  13-75 17.00 16.27  11.42  8.26  14.42  14.77  21.92  9.25 8.74 8.11 9.20 9.49  5.11  23.33  9.20  14.16 (28.6) 14.61  5.82  20.00  10.30  14.50  18.57 17.79  16.30 14.65  12.77 12.31  A l l Manufacturing Industries  11.26 8.87 10.51 10.29 8.82  7.89 8.77 7.90 7.22 7.97 8.11 7.73 8.78  Definitions: Return on Sales: the net p r o f i t before taxes and bond and mortgage i n t e r e s t expressed as a percentage o f sales, l e s s investment income and other revenue. Return on Invested C a p i t a l : the net p r o f i t as above expressed as a percentage of the sum o f the f o l l o w i n g amounts: due to shareholders; mortgage debt; other funded debt; common stock; preferred stock and surplus l e s s d e f i c i t .  4 9  Return on Resources employed; the net p r o f i t as above expressed as a percentage of the t o t a l assets l e s s accumulated depreciation. B.  Conclusions  Conclusion 1 In 1962  the average pharmaceutical firm would have been able to l i q u i d -  ate i t s current assets at only twenty-six percent of t h e i r book value and s t i l l pay o f f i t s creditors i n f u l l . Explanation: the pharmaceutical industry had the highest current r a t i o ^  (3«85) of the f i f t y - o n e industries studied. Conclusion 2 The average pharmaceutical firm i n 1962 was not overly burdened with short term debt and the r i s k of debt was borne to a large extent by the owners. Explanation: the r a t i o of current l i a b i l i t i e s to net worth^ was determined to be (25.6  percent) the twelfth lowest of a l l the  industries studied. Conclusion 3 The average pharmaceutical firm did not invest excessive ownership funds i n assets with a low rate of turnover. Explanation: the r a t i o of fixed assets to net  worth6 (53»3 percent)  ranked 28 highest of the f i f t y - o n e industries studied. The current r a t i o indicates the extent to which the claims of shortterm creditors are covered by assets that are expected to be converted into cash i n a period roughly corresponding to the maturity of the claims. A l though other r a t i o s w i l l measure l i q u i d i t y , the current r a t i o i s the genera l l y accepted measure of short term solvency or l i q u i d i t y . J . F. Weston and E. F. Brigham, Managerial Finance. (Rinehart:Toronto, 1966) p. 70.  5This r a t i o measures the amount of funds supplied by owners against the amount raised by current debt. 6This r a t i o determines the extent to which ownership funds are sunk i n assets with r e l a t i v e l y low turnover.  50 Conclusion 4 The average e t h i c a l firm i n 1964 had a wide margin o f safety i n i t s a b i l i t y to meet annual fixed i n t e r e s t charges. Explanation: the r a t i o o f times i n t e r e s t earned? indicates that the average P.M.A.C. firm earned an operating p r o f i t o f 5«95 times the size o f i t s annual i n t e r e s t charges.  The income statements  for the P.M.A.C. and s i x e t h i c a l firms are shown i n Appendix I . Conclusion 5 Inventory was converted into more l i q u i d assets at a faster rate by the average pharmaceutical firm than by the average firm i n each of thirty-one other industries. Explanation: t h e i r sales to inventory ratio** o f 5«3 ranked the twentieth highest o f the f i f t y - o n e manufacturing industries studied.  A  comparable r a t i o of 5.45 was attained by the average e t h i c a l firm in  1964.  Conclusion 6 A condition o f doing business within the pharmaceutical industry i s the unusually long c o l l e c t i o n period f o r the accounts receivable. Explanation: only ten industries had a longer c o l l e c t i o n period than the f i f t y - s i x days f o r the pharmaceutical industry. The average ?This r a t i o i s determined by dividing p r o f i t before i n t e r e s t and taxes by the t o t a l i n t e r e s t charges f o r a given time period. I t indicates the extent to which earnings could decline without a resultant f i n a n c i a l embarrassment to the firm because o f i n a b i l i t y to meet annual i n t e r e s t costs. The t o t a l P.M.A.C. earnings on e t h i c a l pharmaceuticals i n 1964 was $18,325,315» and the corresponding i n t e r e s t charges were $309,435. H. C. Harley, Minutes and Proceedings, op. c i t . , p. 348. &_he lack o f a standard method o f inventory valuation may r e s u l t i n the use o f r a t i o s based upon non-comparable data. The P.M.A.C. sales i n 1964 were $107,784,503 and the inventory was valued at $19,789,317. Ibid.  51 e t h i c a l firm had a c o l l e c t i o n period of sixty-two days i n  1964.9  The c o l l e c t i o n period can best be evaluated by comparing i t with the terms on which the firm s e l l s i t s products.  The basic  terms of sale within the pharmaceutical industry was net t h i r t y days. was  However, extended dating up to one hundred and twenty days  r e a d i l y available on both seasonal and quantity purchases. In  addition, some e t h i c a l firms offered extended dating to new tomers to help them become e s t a b l i s h e d . ^  cus-  These lengthy c o l l e c t i o n  periods are not a r e f l e c t i o n of the poor f i n a n c i a l condition of the industry's prime customers, r e t a i l pharmacies. i n r e t a i l pharmacies i s r e l a t i v e l y Conclusion  The rate of f a i l u r e  low.^  7  Over a twelve year period, the pharmaceutical industry was more p r o f i t able than the average of a l l manufacturing industries. Explanation: Table IV shows that the average rate of return on sales for the pharmaceutical industry was  64 percent higher than the  average rate f o r a l l manufacturers,  (9*55  5.82  percent).  percent as compared to  S i m i l a r l y , the return on invested c a p i t a l was  percent higher (20 percent as compared to 10.3 return on resources  employed was  percent) and  65 percent higher (14.5  95  the  compared  to 8.78). 9lbid. The P.M.A.C. sales were divided by 365 to determine the average d a i l y sales, which i n turn was divided into the accounts receivables ($18,265,033) to a r r i v e at the number of days (62) that sales were t i e d up In the receivables. lOXwo examples known to the writer are Ciba Co. Ltd. and H.K. Wampole Ltd. l l R e s t r i c t i v e Trade Practices Commission, The Manufacture, D i s t r i b u t i o n and Sale of Drugs. (Queen's Printer:Ottawa, 1963) Appendix Q, p. 78. Over the nine year period from 1951 to 1959 there was an average of only seven f a i l u r e s i n r e t a i l pharmacies. This represented 1.2 percent of a l l r e t a i l f a i l u r e s or only..16 percent of a l l registered pharmacies i n Canada.  52 Conclusion 8 The average e t h i c a l f i r m was more p r o f i t a b l e than the average f i r m w i t h i n the e n t i r e pharmaceutical i n d u s t r y . Explanation: i n 1964 the e t h i c a l f i r m s ' return on sales was about 79 percent higher than the average r e t u r n f o r the pharmaceutical i n d u s t r y (17 percent compared to 9«52 percent). Their return on resources employed was 96 percent higher (28.6 compared to 14.6). Conclusion 9 F i n a n c i a l leverage should be favourable to pharmaceutical f i r m s , since i n 1962 they represented a low r i s k to t h e i r c r e d i t o r s and r e f l e c t e d high earnings. Explanation: conclusions 1 to 4 d i r e c t e d a t t e n t i o n to the r e l a t i v e l y low r i s k f a c t o r s associated with pharmaceutical firms.  Hence,  they may q u a l i f y f o r prime i n t e r e s t r a t e s on debt. Conclusions 7 and 8 i n d i c a t e d that the average f i r m was characterized by a high degree o f p r o f i t a b i l i t y .  Therefore, i n a l l l i k e l i h o o d  pharmaceutical firms on the average would earn more on t h e i r borrowed funds than they pay i n i n t e r e s t charges, magnifying the returns to the owners.^ III.  2  COMPARISON OF MARKETING COSTS INCURRED WITHIN THE ETHICAL PHARMACEUTICAL INDUSTRY  A comparative analysis o f the marketing costs incurred by the P.M.A.C. 13  and s i x member firms i s shown i n I l l u s t r a t i o n 6... 12Financial leverage works both ways however, and i f the cost o f debt was greater than the earnings, i t would be unfavourable to the f i r m . 13H. C. Harley, Minutes and Proceedings. op_. c i t . , pp. 348, 600, 824, 833. 942, 1020 and 1066. D e f i n i t i o n : the marketing costs are expressed as a percentage o f the i n d i v i d u a l firm's sales. The P.M.A.C. f i g u r e s are an aggregate o f forty-one i n d i v i d u a l firms.  53  ILLUSTRATION 6 COMPARISON OF MARKETING COSTS INCURRED BY ETHICAL PHARMACEUTICAL FIRMS PMAC  3.8|  FIRM A  aaSm PS 12.2  MS 10.2  PS T 5 T 0  MS 5.9  FIRM B D 1 3 . 9  PS  10.3  FIRM C D 8.0  PS  19.0  FIRM D 3.0  PS  7.5  FIRM E 2,6  PS  9.3  FIRM F  D  7.5  2  4  9.0 j MS 12.0  MS 8.9 MS 14.7  PS  6  MS  mm  13.4  8 10 12 14  16  Ms 7 . 7  18 20 22 24 26 28 30 32 34 36 38 40  Definitions: CZ3 D = D i s t r i b u t i o n and warehousing costs L__ PS = Personal s e l l i n g costs BB  AD = Administration of marketing a c t i v i t i e s  C D MS - Mass s e l l i n g The P.M.A.C. spent t h i r t y - t h r e e percent of i t s sales on the marketing f u n c t i o n , whereas the amount spent by the s i x i n d i v i d u a l firms varied from twenty-one to t h i r t y - n i n e percent of t h e i r s a l e s .  This spread i n marketing  costs r e s u l t s p r i m a r i l y from d i f f e r i n g degrees of emphasis that i n d i v i d u a l firms placed on t h e i r marketing mix,  as a r e s u l t of separate marketing  p o l i c i e s . Consequently, through a comparison of marketing p o l i c i e s and a t endant marketing mixes, reasons f o r these v a r i a t i o n s may be determined.  54 A.  Comparison o f Marketing Mixes The firms* marketing mixes w i l l be compared under the headings o f :  product p o l i c i e s , d i s t r i b u t i o n p o l i c i e s and promotional p o l i c i e s .  Pricing  p o l i c i e s w i l l not be considered as they do not have a d i r e c t e f f e c t on marketing costs. 1.  Product P o l i c i e s 13 The firms' major product p o l i c i e s are summarized i n Table V. J  TABLE V SUMMARY OF MAJOR PRODUCT POLICIES Firm A Market Research department Licensed products  Firm B  Firm C  Firm D  Firm E YES  Firm F  YES YES  Bulk import OTC product l i n e  MAJOR  MAJOR  MINOR  MINOR  MINOR  MAJOR  Impact of the research dept.  MINOR  MAJOR  MAJOR  MAJOR  MAJOR  MINOR  To a large degree, a firm's success may be related to i t s strategic product p o l i c i e s .  Firm A i s very heavily dependent upon the sales generated  by "a great many compounds brought to (Firm A) through arrangements with well known European pharmaceutical companies".  13lbid., pp. 591-636, 757-825, 870-883, 939-969, 1013-1021 and 1057-1068.  Firms with leading OTC products i n some o f these market segments are r e garded as having a "major" l i n e o f OTC products. Some examples o f these market segments are: cough syrups, cold tablets, lozenges, vitamins, pain r e l i e vers, etc. A "minor" OTC product l i n e refers to very l i m i t e d representation i n these OTC market segments. A research department exerts a major impact on the firm's a c t i v i t i e s i f i t i s able to introduce new o r i g i n a l products that subsequently become leaders i n t h e i r therapeutic market segment. In contrast, a minor influence i s exerted i f the research dept. i s r e l a t i v e l y non-productive regarding o r i g i n a l products or i s only capable o f introducing variations i n o r i g i n a l products already established i n the market segment. These variations may occur i n the form o f package size, dosage form, or chemical formulation. l ^ I b i d . . p. 874.  55 On the other hand, Firm D had introduced into Canada outstanding products from i t s own international research f a c i l i t i e s . ^ 5  The same i s true but to a  l e s s e r extent f o r Firms B. C and E. Only Firm E maintained the f a c i l i t i e s o f a market research department,  that exerted considerable influence on the  planning and implementation o f product strategies.  Firm F imported certain  bulk pharmaceuticals and resold them under i t s own brand name.  I t s OTC  products generated t h i r t y percent o f the firm's sales volume.^ A comparison o f the firm's product assortment i s shown i n Table VI. This i l l u s t r a t e s : the percentage o f the therapeutic market segments, within which the firms compete, the number o f product l i n e s ^ ? , and the size of the product TABLE VI COMPARISON OF PRODUCT ASSORTMENTS Number o f Product Lines  Firm  Product Assortment  Degree o f Representation i n the 24 Therapeutic Market Segments  Firm A  68  298  75 *  Firm B  66  637  79 i  Firm C  73  200  62 $  Firm D  41  234  62 £  Firm E  40  151  50 *  Firm F  75  500  62 %  15lbid..p. 819-821. Their sulfonamide has become one of the most widely prescribed sulfonamides i n the treatment o f urinary t r a c t infections i n Western countries. In I960, t h e i r t r a n q u i l i z e r was a major advance i n psychochemotherapy. I t acted s p e c i f i c a l l y on anxiety and tension states without dulling the patient. In 1963 they introduced another product that represented another important contribution f o r i n addition to i t s psychopharmaceutical properties i t was described as a muscle relaxant of unusual potency*'. M  I 6 l b i d . p . 988. l ? p . Kotler, Marketing Management. (Prentice H a l l Inc.,:Englewood C l i f f s , N.J., I967) p. 289. A pharmaceutical product l i n e refers to a group o f products that are c l o s e l y related because they s a t i s f y a class o f therapeutic needs. The number o f d i f f e r e n t product l i n e s offered by the firm refers to the width of i t s product mix.  56 assortment.--  8  Firm B has the l a r g e s t product assortment (637 products) and  competes i n 79 percent of the therapeutic market segments.  In contrast,  Firm E has the smallest product assortment (151 products) and competes i n just 50 percent of the market segments. 2.  Distribution Policies To cope with emergency conditions, prescription products must be  made available throughout Canada at a l l times.  Consequently, the types of  channels of d i s t r i b u t i o n used become an important p o l i c y decision f o r each firm.  A pharmaceutical firm may d i s t r i b u t e i t s products i n various ways  according to the market to be served, as shown i n I l l u s t r a t i o n Illustration  -'rf'.  7  DISTRIBUTION CHANNELS USED BY THE SIX SELECTED PHARMACEUTICAL FIRMS Wholesaler  >  Firm A  ^Dispensing physicians, iGov't Dept. & I n s t i t u t i o n s  Wholesaler  £  fPharmacies,  -Wholesaler——*  /Pharmacies,  Firm B  Firm C ••——• Wholesaler•-—-4\  Pharmacies,  Firm D Firm E Firm F  —  Wholesaler  •^Primary Channel  »  /Pharmacies, Secondary Channel  ^ Patient D-direct d i s t r i b u t i o n  l ^ I b i d . The product mix refers to the composite of products offered f o r sale by a firm including variations i n a product's dosage forms and package sizes. The depth of the product mix r e f e r s to the average number of items offered by a firm within each product l i n e . In t h i s analysis the depth becomes meaningless due to the averaging out of such large product l i n e s .  57 Hospitals are normally supplied d i r e c t , though they may on occasion buy through the regular trade channels; that i s , through the wholesaler network.  R e t a i l pharmacies  and dispensing physicians are supplied d i r e c t or  through the wholesaler network, or both. Many larger companies prefer to s e l l d i r e c t to the pharmacist and f a c i l i t a t e  t h i s p o l i c y by maintaining warehouses  or depots i n s t r a t e g i c a l l y located c i t i e s .  In some cases, the manufacturers  own or operate t h e i r own warehouses; i n others, a number of manufacturers the f a c i l i t i e s of a warehousing company.  use  However, certain companies prefer  to d i s t r i b u t e t h e i r products e n t i r e l y through wholesalers.  They include  some of the larger firms and most of the smaller ones, who would not f i n d i t economical to maintain t h e i r own d i s t r i b u t i o n f a c i l i t i e s .  Individual firms  choose the channels of d i s t r i b u t i o n most economical i n view of the size and nature of t h e i r market. ties,  However, none r e l y e n t i r e l y upon t h e i r own  as a l l firms d i s t r i b u t e through wholesalers to a certain  facili-  degree.  I t i s basic to the d i s t r i b u t i o n p o l i c y of the e t h i c a l pharmaceutical industry to accept returned prescription products f o r c r e d i t . p o l i c y was found necessary due to: (1)  This  the p r o l i f e r a t i o n of products within  the same therapeutic market segment, (2)  the hesitancy of wholesalers and  pharmacists to stock the complete range of products within each therapeutic market segment, and (3) products.  the r e l a t i v e l y short s h e l f - l i f e  of some of the  Consequently, t h i s p o l i c y was implemented as an inducement to  ensure more complete d i s t r i b u t i o n of prescription pharmaceuticals.  However,  firms vary i n the degree of c r e d i t extended, and i n the conditions under which c r e d i t i s granted.  Generally, most firms accept pharmaceuticals f o r  f u l l c r e d i t provided t h e i r o r i g i n a l container remains unopened and the products  58 are returned p r i o r to t h e i r expiry date.^9 3.  Promotion P o l i c i e s The communication objectives of pharmaceutical firms are twofold,  the dissemination of s c i e n t i f i c information and the promotion of cal products.  pharmaceuti-  Firms maintain that they have a s o c i a l r e s p o n s i b i l i t y i n pro-  viding a rapid dissemination of product information.  Delays could well  cause unnecessary loss of l i f e and suffering. The promotion of a new  product  i s necessary since i t would not be the only e f f e c t i v e medicine within a therapeutic market, however, i t would u s u a l l y present d e f i n i t e advantages for patients with certain conditions.  Nevertheless, the product would not  come into wide usage unless physicians were properly informed of i t s characteristics. Promotion should not be confined only to new products.  Over a  period of time, new information becomes available on indications or contraindications f o r existing products.  Also, the sales for established products  are dependent upon the maintenance of the promotional e f f o r t .  This charac-  t e r i s t i c of competitive r i v a l r y should be expected due to the presence of the p r a c t i c e of non-price competition and the o l i g o p o l i s t i c market structure. As a r e s u l t of the continual enlargement of knowledge, both product and s c i e n t i f i c , and the s h i f t i n g of physicians* preferences, due to increased product d i f f e r e n t i a t i o n , firms attempt to do t h e i r best to influence the 19H. C. Harley, Minutes and Proceedings, op. c i t . . p. 952 and p. 6l6. Firm E paid the wholesaler an additional 15 percent on the value of any returns i n order to ensure that h i s representatives check regularly that pharmacies' stocks of i t s products are i n good condition. The return of out-dated products consistently amounted to 5 percent of Firm C s sales, and v i r t u a l l y a l l of t h e i r returned goods represented a t o t a l l o s s , as only 10 percent of the value of t o t a l returned products could be salvaged.  59 patterns of use that emerge. T r a d i t i o n a l l y a firm's greatest asset has been i t s reputation for q u a l i t y and r e l i a b i l i t y with the nation's prescribing physicians.  Conse-  quently, firms would be hesitant to jeopardize this reputation by w i l f u l misrepresentation  or exaggeration.  General guidelines have been established  i n the P.M.A.C.'s Code of Marketing P r a c t i c e . ^ 2  This i s an attempt to pre-  vent the forces of competitive r i v a l r y from coercing firms to implement business practices that go beyond the e t h i c a l l i m i t s of influencing demand. Additionally, the Food and Drug Directorate exercises controls over the r e l i a b i l i t y of products and product information.  The Directorate must pass  judgment on the safety and e f f i c a c y of products and approve the basic product c i r c u l a r , upon which a l l subsequent promotion i s based.  As a r e s u l t , firms  encounter s t r i c t regulations p a r t i c u l a r l y within the area of communications. A comparison of the firms' promotional blend of t h e i r mass selling21 and personal s e l l i n g expenses i s shown i n I l l u s t r a t i o n VIII. I t indicates that firms with i n d i r e c t channels of d i s t r i b u t i o n have a promotional blend that emphasizes mass s e l l i n g rather than personal s e l l i n g . firms with d i r e c t channels emphasize personal  On the other hand,  selling.  20j_bid., p. 332-40. 2 1  p.  E . McCarthy, Basic Marketing. :(R.D. Irwin:Homewood, I l l i n o i s ,  643.  1964)  Mass s e l l i n g communicates i d e a l s or information to large numbers of customers or i n f l u e n c i a l s at the same time. I t has l e s s f l e x i b i l i t y than personal s e l l i n g , but when the numbers of physicians, pharmacies and hosp i t a l s are large, i t becomes l e s s expensive. For the purposes of t h i s report, mass s e l l i n g i s defined to include: journal advertising, d i r e c t mail, sampling (sales promotion), and public r e l a t i o n s . This c l a s s i f i c a tion system i s used, as i t duplicates that system used to c o l l e c t the o r i g i n a l s t a t i s t i c a l cost data. Recognition i s given to the fact that public r e l a t i o n s i s normally not included as a mass s e l l i n g cost, but rather i s c l a s s i f i e d separately by i t s e l f .  60 ILLUSTRATION 8 PROMOTIONAL BLEND OF MASS AND PERSONAL SELLING ACTIVITIES USED B I ETHICAL PHARMACEUTICAL FIRMS I-ixect Channels of D i s t r i b u t i o n  FIRM F  FIRM  E  Primary Channels are i n d i r e c t  FIRM A  Ratio of personal s e l l i n g to mass s e l l i n g B.  Ratio of mass s e l l i n g to personal s e l l i n g  Comparison of Marketing Costs The marketing costs i n I l l u s t r a t i o n 8 are analyzed and compared on the  b a s i s of the cost of performing the three marketing f u n c t i o n s : d i s t r i b u t i o n , promotion and administration, 1.  The D i s t r i b u t i o n Costs Firms with d i r e c t channels of d i s t r i b u t i o n perform the wholesale  f u n c t i o n , and as a r e s u l t have higher d i s t r i b u t i o n costs than firms with i n d i r e c t channels, everything e l s e equal.  However, when these costs are r e -  l a t e d to the volume of sales as w e l l as the s i z e of the product assortment, as shown i n I l l u s t r a t i o n 9 there appears to be l i t t l e d i f f e r e n c e between the  61 costs incurred by firms supplying d i r e c t or i n d i r e c t channels of d i s t r i b u t i o n . An explanation f o r t h i s may be that economies of s c a l e are being r e a l i z e d by firms with l a r g e r product assortments.  By optimizing the product assortment  firms w i l l achieve the lowest combination of t r a n s p o r t a t i o n , handling, and storage costs on a per u n i t b a s i s .  However, diseconomies of s c a l e may a r i s e  with e x c e s s i v e l y l a r g e product assortments, and t h i s d i l u t e s the economies r e s u l t i n g i n higher per u n i t c o s t s . ILLUSTRATION 9 RATIO OF THE PERCENTAGE DISTRIBUTION COSTS TO THE SIZE OF THE PRODUCT ASSORTMENT Firms with D i r e c t Channels of D i s t r i b u t i o n FIRM A  15.*  FIRM B  22  FIRM C  FIRM F  15  Firms with Primary I n d i r e c t Channels of D i s t r i b u t i o n FIRM D FIRM E  1 8  k  8 12 16 20 2k 28 32 36 k0 RATIO SCORE  DISTRIBUTION COSTS DOLLAR AMOUNT Volume of Sales x s i z e of product assortment  X 1,000  Firm C had a d i s p r o p o r t i o n a t e l y high r a t i o compared to the other f i r m s .  62 This may be because: a)  That firm had the second smallest product assortment and appears not to be benefiting from economies of scale to the same degree as firms A, B and F.  b)  Only Firm C distributed i t s products direct, but d i d not own i t s own warehousing f a c i l i t i e s .  The cost of h i r i n g t h i s wholesaling  service may have been higher than the operating costs associated with either d i r e c t or i n d i r e c t channels.22 Firm D. on the other hand, had the lowest r a t i o .  This may be the  r e s u l t o f (1) an i n i t i a l low l e v e l o f d i s t r i b u t i o n costs (3 percent o f sales) made possible by the i n d i r e c t channels, and (2) a r e l a t i v e l y large product assortment (234). 2.  Promotion Costs A comparison of the firms* t o t a l promotional costs and t h e i r blend  of the promotional elements i s shown i n I l l u s t r a t i o n 10.  These elements i n -  clude: personal s e l l i n g and mass s e l l i n g a c t i v i t i e s . a)  Personal S e l l i n g Costs Firms with i n d i r e c t channels o f d i s t r i b u t i o n incurred a  lower percentage of personal s e l l i n g costs than those firms with d i r e c t channels, as shown i n I l l u s t r a t i o n 1 1 .  This would be expected as some of the  salesman's tasks are transferred to the wholesaler f o r implementation. Consequently, both Firms D and E have substantially  smaller f i e l d sales s t a f f s ,  as shown i n Table VII. 22j_t would be necessary to consider c a p i t a l costs, operating costs, opportunity costs and convenience i n order to evaluate the economics o f these alternate methods o f d i s t r i b u t i o n : d i r e c t , ownership of f a c i l i t i e s , d i r e c t rental o f f a c i l i t i e s and i n d i r e c t . This evaluation l i e s beyond the scope o f t h i s thesis.  63  ILLUSTRATION 10 COMPARISON OF THE PROMOTIONAL BLENDS OF ETHICAL  PHARMACEUTICAL FIRMS  Promotional expanses  T = Total promotion expense  as a  \ l PS= Personal s e l l i n g expense per-  1 I JA= Journal advertising expense B  centage  DM= Direct mail expense  r~l S = Sampling expense of  PR- Public relations expense  sales  1 1 •  r_rJ  25"!l5'2 k5 3*5! 22. 16.1 jl*.! l4.5{2.8|L5 :  T  jPSjJAiDMj i  P.M. A.C.  i  PR  T  J P S I J A J D M !  i  S  ;  P  R  I i—I—i— FIRM A  ! U |LSS5?|3lil9{l.?l3:54'3^  *9.l\io.l\  T S P S I J A ' D M I S  J  L  FIRM B  :  P  R  T  I P S - J A S D M I S  i  ! : ! FIRM C  IPR  ;  T  :  P  S  «  J  A  :  D  M  |  S  '<FR  LThl ! 9 J L 2! 5.7i L T J 6.1I2I.I 'EM; 2,?, . 7! 2.7? 1.6 t  FIRM  D  P S !  J  A  |  D M !  S  :  ' FIRM I I EI • I—I—I—I—I  P  R  T  J  P  S  '  J  A  J  D  M  S  I FIRM . I ' F  I  I  1  I  S  | P  I  6k ILLUSTRATION 11 ANALYSIS OF PERSONAL SELLING COSTS FIRM A  12.2  1  FIRM B  10.3  n.2  FIRM C  19  FIRM D FIRM E  !  1  i 29.2  •  • H _ _ i 3 ^ 9.3  | 29  FIRM F  3  6  9 12 15 1 8 21 Zk 2? 30 33 36 39 k2 k$ k8 51 54 57 60 RATIO SCORE  •  Ratio of: Absolute d o l l a r cost o f personal s e l l i n g Total Volume o f ethical sales  ^ ^ Q Q  Ratio of: Absolute d o l l a r cost of personal s e l l i n g Volume of sales x number of salesmen  ^  ^oo  Ratio of: Absolute d o l l a r cost o f personal s e l l i n g x 100 Vol. o f sales x size o f product assortment TABLE VII SIZE OF THE FIELD SALES FORCE FIRM A  80 men  FIRM D  kO men  FIRM B  92 men  FIRM  E  35 men  FIRM C  66 men  FIRM F  90 men  Economies of scale may be r e a l i z e d i n the area of personal s e l l i n g costs.  An optimum sized f i e l d sales force w i l l r e s u l t i n the lowest  cost per salesman r e l a t i v e to both the s i z e of the product assortment and the tasks to be performed.  Further analysis of the personal s e l l i n g costs  65  i n I l l u s t r a t i o n 11 r e l a t e d them to the number o f detailmen (salesmen), and the s i z e o f the product assortment. I n each case, i t was found that Firms C, D and E incurred g e n e r a l l y higher cost r a t i o s . had i n common were:  The c h a r a c t e r i s t i c s that these firms  a small product assortment, a small f i e l d sales s t a f f ,  a minor l i n e o f OTC products and the wholesaling functions were undertaken to some degree by independent wholesale middlemen.  These c h a r a c t e r i s t i c s were  d i r e c t l y opposite i n nature f o r Firms A. B and F. I t would appear that these firms were b e n e f i t i n g from economies o f s c a l e , i n t h i s s t a t i c a n a l y s i s . However, Firm B has such a l a r g e f i e l d sales f o r c e and product assortment r e l a t i v e to a l l other f i r m s , i t s operation would be suspect o f diseconomies. S u f f i c i e n t data are not a v a i l a b l e to substantiate t h i s suspicion, b)  Mass S e l l i n g Costs Mass s e l l i n g costs include those expenditures on sampling,  j o u r n a l a d v e r t i s i n g , d i r e c t mail and p u b l i c r e l a t i o n s .  A comparison o f the  f i r m s ' blending o f these mass s e l l i n g elements i s shown i n I l l u s t r a t i o n 12. I t i l l u s t r a t e s the degree o f emphasis placed upon each mass s e l l i n g  element  by: (1) an i n d i v i d u a l f i r m , (2) a l l firms, and (3) firms w i t h a common promo t i o n a l blend between mass s e l l i n g and personal s e l l i n g . 1)  Sampling costs Sampling i s an important sales promotional p r a c t i c e i n  the pharmaceutical i n d u s t r y , as physicians are r e l u c t a n t to prescribe any product e x t e n s i v e l y without p r i o r c l i n i c a l experience.  Since a pharmaceut-  i c a l product may be an e x c e l l e n t medicine f o r one p a t i e n t , but l e s s s u i t a b l e f o r another s u f f e r i n g from an apparently i d e n t i c a l c o n d i t i o n , sampling has helped p h y s i c i a n s t o p r e s c r i b e the most e f f i c a c i o u s product i n each p a r t i c u l a r case.  Also, samples are often used i n the treatment o f p a t i e n t s i n poor  f i n a n c i a l circumstances.  66 ILLUSTRATION 12 COMPARISON OF MASS SELLING BLENDS* Firms Emphasizing Personal S e l l i n g FIRM A FIRM B FIRM C. FIRM F Firms Emphasizing Mass S e l l i n g FIRM D  40.5  FIRM E  8*2  io  20  30  55  58  So"  7_»  55  96*  i5o  Percent of Total Mass S e l l i n g Expenditures j Journal Advertising costs 01 j •H  D i r e c t M a i l costs | Sampling costs P u b l i c Relations costs  * The d i s t i n c t i o n between the f i r m s ' mass s e l l i n g elements i s not as c l e a r as has been presented here.  Often d i r e c t mailings contain samples, and the  method of a l l o c a t i n g these sample costs i s not homogeneous f o r a l l  firms.  Firm E charges both the d i r e c t mailing costs and the sampling costs to d i r e c t m a i l , while other firms charge the sampling costs associated with d i r e c t mailings to sampling c o s t s .  67 The degree of emphasis placed upon the practice of sampling as compared to the other elements i n the mass s e l l i n g blend i s shown i n I l l u s t r a t i o n 12.  Firms A. C and D placed major emphasis upon sampling.  Firm D*s products had outstanding q u a l i t i e s and physicians would be i n c l i n e d to prescribe them extensively i f they could be persuaded to give them an i n i t i a l t r i a l .  Since this firm did not place major emphasis  upon personal s e l l i n g , sampling was emphasized.  Of a l l firms, i t had the  second highest (3*6) percentage expenditure on sampling, and i t placed the greatest degree o f emphasis upon t h i s element (40.5$ of -11 mass s e l l i n g costs) among those firms (D and E) whose promotional blend emphasized mass s e l l i n g . On the other hand, Firm A d i d not choose to emphasize mass s e l l i n g as a promotional strategy, nevertheless, i t did incur some mass s e l l i n g costs, (5»9 percent of sales). far  Of i t s mass s e l l i n g expenditures, by  the greatest emphasis was placed upon the use o f a sampling program. In  f a c t , Firm  A had the highest percentage (47.5) o f a l l firms. Such a heavy  reliance upon t h i s mass s e l l i n g element may be explained by the firm's rapid rate o f new product introductions.  This was made possible as a r e s u l t  of the connections Firm A had established with European pharmaceutical manufacturers. Firm C incurred the highest l e v e l of sampling costs (5.4 percent of sales) o f a l l firms even though i t placed greater emphasis upon personal s e l l i n g than mass s e l l i n g .  Of the mass s e l l i n g elements, Firm C placed the  greatest emphasis upon sampling  (45 percent o f a l l mass s e l l i n g costs). This  extensive usage of a sampling program may be explained by the type of products Firm C markets. I t s most outstanding products compete i n the corticosteroid  68 and a n t i b i o t i c market segments, that are characterized by (1) a low cross e l a s t i c i t y of demand between competing products and (2) a large and expanding d o l l a r volume. In order to secure an increasing market share of these p o t e n t i a l l y p r o f i t a b l e market segments, Firm C has promoted products that are d i f f e r e n t i a t e d by placing a heavy reliance upon the sales promotional technique of sampling. (2)  Journal Advertising Costs Generally, reminder advertising i n both medical and pharm-  aceutical journals only received a minor emphasis within the mass s e l l i n g mix.  Firms D and E spend only 1.7 and 1.2 percent of t o t a l sales respectively  on t h i s element, i n spite of t h e i r o v e r a l l emphasis upon mass s e l l i n g s t r a t egies.  This represented 19.2 and 8.2 percent of t h e i r t o t a l mass s e l l i n g  expenditures, respectively, as shown i n I l l u s t r a t i o n 12.  Although Firm F  emphasized personal s e l l i n g , i t incurred the highest (2.7 percent of sales) journal advertising costs of a l l firms.  I t allocated 35 percent of i t s  t o t a l mass s e l l i n g expenditures to both t h i s and the sampling (3)  elements.  Direct M a i l Costs Direct mail received the l e a s t emphasis of a l l the mass  s e l l i n g elements from those firms that had d i r e c t channels of d i s t r i b u t i o n . In contrast, Firms D and E had i n d i r e c t channels and placed considerable emphasis upon the use o f d i r e c t mailings.  Firm E had the highest expenditure  (5.7 percent of sales) of a l l firms on d i r e c t mail.  This element accounted  for 38.8 percent o f the t o t a l mass s e l l i n g expenditures.  Firm D had the  second highest expenditure (3 percent of sales) on d i r e c t mail, and only placed greater emphasis on sampling within i t s mass s e l l i n g blend (40.5 percent as compared to 33*8 percent).  69 (4)  Public Relation Costs Public relations includes the costs of creating or main-  taining a p u b l i c personality or reputation.  Most firms did not consider  t h i s element to be important, however, there were two important shown i n I l l u s t r a t i o n s 11 and  exceptions  12.  Firm B has been established i n Canada f o r seventy years and has accumulated the l a r g e s t product assortment.  I t s international r e -  search f a c i l i t i e s have created many outstanding products over the years, and the firm's name was perhaps the best known of a l l firms.  However, recently  few new products have been introduced and combined with i t s publicized c i v i c law s u i t s i n the United States, i t s reputation has diminished.  Consequently  i t i s not surprising that Firm B should consider public relations to be the most important mass s e l l i n g element. sales, which represented 63.5  I t allocated 5«7 percent of i t s t o t a l  percent of a l l mass s e l l i n g , to public r e l a -  tions. Only i n the l a s t seven years has Firm E become a major s e l l e r of pharmaceutical products i n Canada, although i t has been established here since 1949 study, Firm E  and i n the United States since 1830. has the smallest product assortment  l i n e s (40), and the l e a s t number of detailmen (35).  Of the firms i n t h i s  (151). the fewest product Hence, i t i s not sur-  p r i s i n g that i t s image would be that of a small, r e l a t i v e l y  unimportant  21 pharmaceutical house.  But i t has the f i f t h largest sales volume i n Canada.  Currently Firm E spent 6.1 on public r e l a t i o n s .  percent of i t s sales, the highest of a l l firms,  This represented 41.5 percent of the mass s e l l i n g  Harley, Minutes and Proceedings, op.cit.. p.954.  70 expenditures.  The development of i t s personality centered around a number  of s p e c i a l services provided f o r medicine, pharmacy and nursing, as well as  22 f o r l a y groups interested i n mental health. c)  Administration Costs Administration costs r e f e r to the cost of administering  the  marketing functions, including product and p r i c i n g management and market research.  The analysis of these costs i s hampered by the tendency of firms  to t r e a t t h i s area as a miscellaneous  classification.  Also, Firms B and C  23 do not i s o l a t e t h e i r administration costs.  Firm E had the highest l e v e l  of administration costs (7-3 percent of s a l e s ) .  This i s p a r t i a l l y explained  by the presence of i t s marketing research department. hand, had the lowest l e v e l of administration costs. of the firm's smallrproduct-assortment C.  Firm D. on the other This may be the r e s u l t  and f i e l d sales s t a f f .  Summary The marketing costs incurred by s i x e t h i c a l pharmaceutical  varied from 21 to 39 percent of t h e i r sales. expenditures  firms  These costs resulted from  i n the areas of d i s t r i b u t i o n , personal s e l l i n g , mass s e l l i n g  and administration.  When firms adopted a p o l i c y of d i r e c t d i s t r i b u t i o n ,  I b i d . . pp.957-8. These services include: the sponsor and d i s t r i b u ution of information and training films; the t r a i n i n g of detailment to teach closed chest cardiac message combined with mouth-to-mouth breathing i n the event of heart arrest; the provision of closed c i r c u i t colour TV to medical conventions; i n t e r n a t i o n a l telephone l i n k s f o r pharmaceutical and medical meetings; sponsorship and organization of conferences on mental health matters; and the d i s t r i b u t i o n of two p e r i o d i c a l s . The special i n t e r e s t displayed by t h i s f i r m i n the area of mental health i s explained by i t s s i g n i f i c a n t representation i n the t r a n q u i l i z e r therapeutic market segment by leading products. >This i n turn casts some doubt on the comparability of t h e i r other marketing costs, as they may include some administration costs. However, i t would be more probable that the marketing administration costs would be included i n the general administration costs. 2  71 t h e i r d i s t r i b u t i o n costs were at a higher l e v e l , (4.6 compared to 2.7  and 3 percent of sales).  _osts were higher, (10.3 of s a l e s ) .  to 13-9  percent  as  S i m i l a r l y , t h e i r personal s e l l i n g  to 19 percent as compared to 7*5  and 9.3  percent  In contrast, mass s e l l i n g received greater emphasis when firms  adopted a p o l i c y of i n d i r e c t d i s t r i b u t i o n .  The mass s e l l i n g blend was com-  posed of four elements, sampling, journal advertising, d i r e c t mailings, and public r e l a t i o n s . The size of the expenditure  f o r each element varied accor-  ding to the p o l i c i e s that were implemented by the firm. Sampling costs were higher f o r firms whose products were (1) ized by a rapid rate of new product introduction, (2) t h e i r respective theraupeutic market segment, or (3)  character-  outstanding leaders i n characterized by a low  cross e l a s t i c i t y of demand within a highly competitive, yet expanding, market segment. of sales.  Journal advertising costs were generally very low, below 2 percent Direct mailing costs were higher f o r firms that had i n d i r e c t chan-  nels and few detailmen, percent).  percent of sales as compared to 0.4  to  1.3  Public r e l a t i o n s costs generally were not an area of major expen-  diture, (0.6  to 1.6  t h i s area (5*7 ality.  (3 and 5»7  percent).  and 6.1  However, two firms incurred extensive costs i n  percent) i n an e f f o r t to increase t h e i r public person-  Administration costs tended to be below 4 percent of sales, however,  Firm E had a higher l e v e l (7.3  percent) p r i m a r i l y due to i t s market research  department. IV  COMPARISON OF MARKETING COSTS INCURRED BY FIRMS IN OTHER INDUSTRIES  An evaluation of the magnitude of the marketing costs incurred by e t h i c a l pharmaceutical  firms becomes more meaningful when they are compared with  a s i m i l a r analysis of marketing costs incurred by firms i n other i n d u s t r i e s .  72 The relationship between the l e v e l s of marketing costs i s shown i n I l l u s t r a t i o n 13.  This involves a comparison between the s i z e and composition o f  marketing costs f o r the P.M.A.C. and eight firms from four other industries. The l e v e l of the t o t a l marketing costs incurred by each o f these firms was l e s s than that o f the P.M.A.C. (33 percent of sales).  I t i s of i n t e r e s t  to note that even those firms within the highly competitive soap and t o i l e t r y industry had s u b s t a n t i a l l y lower t o t a l marketing costs (30,25.7 and 23.1 percent o f sales) than the P.M.A.C. average.  Only the pharmaceutical  firms A and D had t o t a l marketing costs that were lower (25.9 and 21.4 percent) than some o f the non-pharmaceutical firms. A. D i s t r i b u t i o n Costs The cost o f performing the d i s t r i b u t i o n function was generally higher 24 i n the non-pharmaceutical firms, as shown i n I l l u s t r a t i o n 13.  F i v e of the  eight firms had higher d i s t r i b u t i o n costs than the P.M.A.C. ( 3 . 9 percent).  25 Perhaps the more intensive d i s t r i b u t i o n  p o l i c y adopted by most of these  firms may explain i n part t h e i r higher d i s t r i b u t i o n costs.  As a conse-  quence of t h i s p o l i c y a more extensive i n s t i t u t i o n a l structure became necessary, since many products ( f o r example, toothpaste) were sold through both d i r e c t and i n d i r e c t channels involving more than one type of wholesaler and retailer. ^Special J o i n t Committee o f the Senate and House of Commons, Consumer Credit.(Queen's Printers:Ottawa, 1966) # 12,17,18,22 and 23,pp.913,1240, 1292,1647,1782. Data related to the bakery and soft drink firms were obtained from personal correspondence. 25 Intensive d i s t r i b u t i o n refers to the t o t a l marketing area over which d i s t r i b u t i o n i s desired, as well as the a v a i l a b i l i t y of the products i n a large number o f outlets, without regard as to type.  73  ILLUSTRATION 1 3 COMPARISON OF MARKETING COSTS INCURRED BY NON-PHARMACEUTICAL FIRMS IN I 9 6 5 P . M . A . C * (1964)  FS 15  1  BAKERY FIRM SOFT DRINK FIRM  5.5  • B  3.7  I  2m4 4.6 6  -6.1 14.7  10.1  5_  13  17-3  I  4.6  SPECIALIZED FOOD  £jD  I  7.1  B.5  I  7.2  7.3  FOOD INDUSTRY BABY FOOD  GENERAL FOOD  2.;l  in  FIRM 2 FIRM 3  L__  15.2  SOAP & TOILETRY INDUSTRY FIRM 1  10.2  9.7  10.9  ]  18  1 0 iiTT 1 2 14 16 l b 20 22 24 26 28 3 0 3 2 3 4 Percentage of Sales  _ D i s t r i b u t i o n and warehousing costs  jjJAL - Administration of marketing  activities  Q p S - Personal s e l l i n g costs  r]iMS - Mass s e l l i n g costs *  The P.M.A.C. marketing costs represent the aggregate marketing costs of forty-one e t h i c a l pharmaceutical f i r m s , expressed as a percentage of t h e i r aggregated revenues obtained from the s a l e of e t h i c a l products o n l y .  B.  Personal S e l l i n g Costs A s u b s t a n t i a l v a r i a t i o n i n the l e v e l s of personal s e l l i n g costs i s noted  i n I l l u s t r a t i o n 1 3 . The P.M.A.C. incurred a much higher l e v e l of personal s e l l i n g cost ( 1 5 percent) than any of the other f i r m s , r e s u l t i n g  primarily  74 from the nature of the product.  I t s complex chemical structure together with  the potential danger of misuse causes firms to reply upon personal s e l l i n g directed towards physicians and pharmacists.  In order to communicate effec-  t i v e l y with t h e i r educated audiences, detailmen are more highly educated and trained than most salesmen. Firms D and E d i d not emphasize personal s e l l i n g , nevertheless, t h e i r personal s e l l i n g costs were s t i l l substantially higher (7.5 and 9«3 percent, I l l u s t r a t i o n 10) than that o f most non-pharmaceutical firms considered i n I l l u s t r a t i o n 13. C.  Mass S e l l i n g Costs Of the eight non-pharmaceutical firms, f i v e had higher mass s e l l i n g  costs than the P.M.A.C. (10.2 percent, I l l u s t r a t i o n 13). These firms were able to communicate d i r e c t l y with the consumer, and benefit from economies of scale i n t h e i r mass media advertising campaigns.  Of the pharmaceutical  firms studied, Firm E placed the greatest degree of emphasis upon mass s e l ling.  Nevertheless, i t s expenditures (14.7 percent, I l l u s t r a t i o n 10) were  exceeded by Firms 1 and 2 (17.3 and 16.1 percent) within the highly competit i v e soap and t o i l e t r y industry even when economic benefits they derived from the use o f mass media advertising were considered. D.  Administration Costs Marketing administration costs were available f o r only four o f the  non-pharmaceutical  firms.  The lack o f a standard d e f i n i t i o n o f these  26„arley, Minutes and Proceedings, op. c i t . pp. 341-3. Just over f o r t y percent o f the detailmen employed i n the P.M.A.C. had u n i v e r s i t y degrees, and seventy-two percent had some u n i v e r s i t y t r a i n i n g . A l l of them received p r e - f i e l d t r a i n i n g , varying from one week to six months. Seventy-five percent o f the member firms supplemented t h i s training by refresher training on a regular basis.  75 costs makes them non-comparable and hence t h e i r analysis i s not p a r t i c u l a r l y meaningful to t h i s study. In summary, pharmaceutical  firms generally incurred higher t o t a l mar-  keting costs than firms i n other i n d u s t r i e s . Although the d i s t r i b u t i o n costs of pharmaceutical  firms appeared to be s l i g h t l y lower, almost without excep-  t i o n t h e i r personal s e l l i n g costs were higher.  The firms' mass s e l l i n g costs  were generally higher i n these other industries, p a r t i c u l a r l y i n the soap, t o i l e t r y and food i n d u s t r i e s . V.  RELATIONSHIP BETWEEN THE MARKETING COSTS AND  THE OVER-ALL SUCCESS OF  THE PHARMACEUTICAL FIRMS The r e l a t i o n s h i p between a pharmaceutical  firm's success 7 and the l e v e l  of i t s marketing costs i s shown i n I l l u s t r a t i o n 14.28  2  i  s  expressed  q u a n t i t a t i v e l y by the r a t i o of the firm's rate of return on sales to i t s l e v e l of marketing costs. 9 2  The r a t i o s for Firms D, E and B are explained  below. A.  Firm D Firm D earned the highest r a t i o , 0.95'  This may be considered to be  the result of i t s a b i l i t y to create t r u l y outstanding products, combined with t h e i r prompt acceptance by prescribing physicians. was  Hence, t h i s firm  able to exert the l e a s t amount of marketing e f f o r t (21 percent) i n pro-  curring sales that yielded the second highest rate of return (20 percent). 27For purposes of t h i s study, the o v e r - a l l success of the firm i s measured by the rate of return on i t s sales p r i o r to i n t e r e s t and taxes. 28ibid.. pp. 348, 600, 824, 833, 942, 1020 and 1066. 29_his r a t i o i s not meant to i n f e r that a firm's success i s due only to the l e v e l of marketing costs that are incurred. The r a t i o i s used as a tool f o r the ordering and evaluation of the firm's performance on the assumption that the presence of an active marketing department, as determined by the l e v e l of marketing costs, has some e f f e c t on the rate of return.  76 ILLUSTRATION Ik RELATIONSHIP BETWEEN THE MARKETING COSTS AND THE OVER-ALL SUCCESS OF THE PHARMACEUTICAL FIRMS PMAC FIRM A  25.9  1  FIRM B FIRM C FIRM D FIRM E  33.6  FIRM F  32.2  3  __2 |  k 8 12 16 20 2k 28 32 36 Level of Marketing Costs percentage of Sales  ____  k 8 12 16 20 2k 28 Rate of Return on Sales  3  J. 2 .3 b .5 J6 .7 .8 .9 1 Ratio of the Rate of Return to Marketing Costs  However, the continued success of firms with leading therapeutic products w i l l be altered as a r e s u l t o f the passage o f recent Canadian l e g i s l a tion.  Under Section 67 of the Patent Act, compulsory licences may be issued  under a patent whenever there has been an abuse of exclusive r i g h t s .  After  the expiration of three years from the date of issuance of a patent, exclusive rights may be deemed to have been abused i f the public demand f o r the patented a r t i c l e i s not being met to an adequate extent and on reasonable terms.30 Currently, two compulsory licences have been granted f o r Firm D's largest s e l l i n g single product.  In each case the rate o f compensation f o r  Firm D amounted to l e s s than two percent of t h e i r product's s e l l i n g p r i c e . ^ R e s t r i c t i v e Trade Practices Commission, op., c i t . . p. 102.  77 Consequently, i t w i l l o f f e r no protection whatever to t h i s s e l l i n g p r i c e and active p r i c e competition w i l l be expected.  Furthermore, a licence application 31  has been made f o r Firm D*s second largest s e l l i n g product.  As a r e s u l t , the  management o f Firm D does not expect t h e i r current rate o f return (20 percent) to continue i n the future. B.  Firm E Firm E had the highest rate o f return on sales (28.2 percent) and second  highest l e v e l o f marketing costs (33.6 percent) of a l l firms studied. The f a c t that i t s r a t i o of 0.83 was second only to Firm D, was s i g n i f i c a n t i n l i g h t o f i t s unusual marketing p o l i c i e s . Only Firm E appeared to be under the influence of the marketing concept. I t was t h e i r general p o l i c y to develop new products i n t h e i r research laborat o r i e s , that would be i n l i n e with the desires of the national market, as determined by t h e i r market research department.32  Consequently, a therapeutic  need was clear before a new product was introduced.  This product need not be  unique within i t s market segment, but i t must offer the prescribing physician d e f i n i t e advantages.33 C.  Firm B Firm B had the lowest r a t i o o f 0.35*  I t incurred the t h i r d highest l e v e l  of marketing costs (33*2 percent) while at the same time i t earned the lowest rate of return (11.7). Their low r a t i o may i n part be explained by t h e i r lack o f major new product introductions and perhaps the presence of diseconomies o f scale.  Firm B's product assortment was by f a r and away the largest  3%. c. Harley, Minutes and Proceedings, op. c i t . p. 762. 3 i b i d . . p. 948. 2  3 3  I b i d . , p. 952.  78 of the s i x pharmaceutical firms (637 products) and i t represented 200 percent more products than the assortment sold by Firm D.  Similarly,  the size of  t h e i r f i e l d sales s t a f f (92 men) was l a r g e r than a l l other firms representing 130 percent more men than employed by Firm D.  These figures together with  t h e i r low rate of return would appear to indicate that Firm B i s experiencing a p r o l i f e r a t i o n of products and detailmen, resulting i n a d i l u t i o n of the economies to be gained from having the optimum size i n both i t s f i e l d sales s t a f f and product assortment. From the v a r i a t i o n i n the sizes of the firm's r a t i o s i n I l l u s t r a t i o n 14, a pattern has emerged.  Firms D and E had similar basic marketing p o l i c i e s i n  common, as well as achieving the highest r a t i o s . Consequently, one i s i n c l i n e d to r e l a t e these p o l i c i e s of i n d i r e c t d i s t r i b u t i o n and primary emphasis upon the use of mass s e l l i n g methods within the promotional mix, to the firm's success.  A more thorough study, involving a larger number of firms over a  longer period of time, would be necessary i n order to assert whether or not t h i s i s a cause and e f f e c t relationship.  However, i n an attempt to further  substantiate t h i s relationship, the firm's marketing e f f o r t i s re-analyzed from a p r o d u c t i v i t y viewpoint i n Chapter Five. VI.  SUMMARY  The predominant f i n a n c i a l c h a r a c t e r i s t i c s of the pharmaceutical indust r y were determined by the comparison of i t s f i n a n c i a l r a t i o s to other industries.  These c h a r a c t e r i s t i c s include:  (1) a low r i s k of debt to creditors,  (2) an unusually long c o l l e c t i o n period f o r the accounts receivable, and (3) a high degree of p r o f i t a b i l i t y . The t o t a l marketing costs varied between the individual firms, p r i m a r i l y as a r e s u l t of the d i f f e r e n t degrees of emphasis that firms placed upon t h e i r  79 marketing mix.  Product p o l i c i e s varied i n terms of:  (1) the impact of l a b -  oratory research upon the firm's a c t i v i t i e s , and (2) the size and width of the firm's product assortment.  The d i s t i n c t i o n between the firm's d i s t r i b u -  t i o n p o l i c i e s mainly centered upon the implementation of either d i r e c t or i n d i r e c t channels of d i s t r i b u t i o n to r e t a i l pharmacies.  Firms diverged on  t h e i r promotional p o l i c i e s i n t h e i r i n i t i a l emphasis upon either personal or mass s e l l i n g promotional methods.  I t was apparent that firms with d i r e c t  channels of d i s t r i b u t i o n emphasized personal s e l l i n g ,  while mass s e l l i n g  methods were emphasized by firms with i n d i r e c t channels. Marketing costs were analyzed on the basis of the cost of performing three marketing functions, d i s t r i b u t i o n , promotion and administration. D i s t r i b u t i o n costs were higher as a percentage of sales f o r firms with d i r e c t channels of d i s t r i b u t i o n .  However, when these costs were related to  the s i z e of the product assortment being distributed, there appeared to be l i t t l e difference i n the costs incurred by firms supplying d i r e c t or i n d i r e c t channels of d i s t r i b u t i o n .  I t was  evident that some firms were benefit-  ing from economies of scale with regard to the size of their product assortment. Promotional costs were composed of both personal s e l l i n g and mass s e l l i n g costs.  Personal s e l l i n g costs were lower as a percentage of sales  for firms with i n d i r e c t channels of d i s t r i b u t i o n , however, they were higher on both a per salesman and per product basis.  Hence, firms with i n d i r e c t  channels may not be benefiting from economies of scale to the same degree as some of the firms with d i r e c t channels of d i s t r i b u t i o n .  Mass s e l l i n g  cost, on the other hand, refers to the cost of: sampling, journal advertising, d i r e c t mail, and public r e l a t i o n s .  Sampling received the greatest emphasis,  80 within the mass s e l l i n g mix, from firms who had either superior products or a rapid rate of new product introduction.  In contrast, journal advertising  received only minor emphasis by most firms. Direct mail received predominant emphasis by those firms using i n d i r e c t channels and emphasizing the mass s e l l i n g method of promotion.  Public r e l a t i o n s costs were incurred when firms  were concerned over the state of t h e i r public personality or reputation. Administration costs were generally not a s i g n i f i c a n t portion of the t o t a l marketing costs.  However, Firm E's administration costs amounted to  7.3 percent of sales, p r i m a r i l y due to the i n c l u s i o n of i t s market research department costs. The P.M.A.C. incurred higher marketing costs (33 percent) than firms i n other i n d u s t r i e s .  This difference was p r i m a r i l y due to s u b s t a n t i a l l y greater  personal s e l l i n g f o r the pharmaceutical  firms, which was not o f f s e t  completely  by the higher l e v e l of mass s e l l i n g costs incurred by the non-pharmaceutical firms. The relationship of a firm's marketing costs to i t s o v e r a l l success was expressed by the r a t i o of the rate of return on sales to the t o t a l marketing costs.  This r a t i o was highest f o r those firms that had i n d i r e c t channels of  d i s t r i b u t i o n and emphasized mass s e l l i n g promotional methods.  CHAPTER V DETERMINATION OF THE PRODUCTIVITY FOR PHARMACEUTICAL FIRMS* MARKETING DEPARTMENTS I.  INTRODUCTION  As f a r back as 1 9 3 8 , Steward and Dewhust, i n Does D i s t r i b u t i o n Cost Too Much, were concerned with measuring marketing's contribution to society. Over the years, p r o d u c t i v i t y theory had been developed and refined to the point where i t provides a sound basis f o r the quantitative measuring of marketing's productivity.  Empirical studies have been conducted on both wholesale and  r e t a i l marketing i n s t i t u t i o n s .  However, no record i n current p e r i o d i c a l l i t -  erature has been found that applies productivity theory to the marketing departments of manufacturing firms. This chapter i s concerned with the application of productivity theory to the marketing departments of various pharmaceutical manufacturing firms. This application i s undertaken from both a normative and a descriptive approach. The normative approach purports to determine productivity measures under i d e a l conditions,  that i s , the measures are determined under theoretical  The descriptive approach, on the other hand, purports to describe  conditions. the deter-  mination of p r o d u c t i v i t y measures as they are actually calculated.  Three  p r o d u c t i v i t y measures are calculated and interpreted into a ranked order of e f f i c i e n c y f o r each firm's marketing II.  department.  A NORMATIVE APPLICATION OF PRODUCTIVITY THEORY TO PHARMACEUTICAL FIRMS' MARKETING DEPARTMENTS  Under a normative application of p r o d u c t i v i t y theory to the manufacturing firm's marketing departments, the costs of performing a l l marketing are r e a d i l y i d e n t i f i e d and i s o l a t e d .  functions  This permits t h e i r c l a s s i f i c a t i o n into  82 value added and value contributed, so that the value added costs may be aggregated i n order to a r r i v e at the marketing department's t o t a l economic output. The normative approach also allows the selection of the marketing department's most appropriate u n i t measures of input. A.  The Determination of the Marketing Department's Economic Output The marketing department's economic output i s determined by the i n i t i a l  c l a s s i f i c a t i o n of the costs of performing each marketing function into either value added or value contributed, followed by the aggregation of the value added costs. 1.  D i s t r i b u t i o n Costs Total D i s t r i b u t i o n costs r e s u l t from three d i s t i n c t d i s t r i b u t i o n  tasks.  These tasks include:  and a l l o c a t i o n , and ( 3 )  ( l ) sorting out and accumulation, (2) storage  transportation.  The c l a s s i f i c a t i o n of the costs  asociated with the performance of these tasks into value added and value contributed i s shown i n Table VIII a)  Sorting Out and Accumulation Costs Since pharmaceutical firms maintain shipping departments,  the tasks of sorting out and accumulation w i l l be undertaken.  However, some  of the costs resulting from the performance of these tasks may be j o i n t costs with other departments within the manufacturing firm.  Insurance, u t i l i t y and  some depreciation costs, f o r example, would most l i k e l y be j o i n t costs with departments that share a common building.  Consequently, an a r b i t r a r y basis  of a l l o c a t i n g these costs between the various departments would have to be undertaken. b)  Storage and Allocation Costs Storage and a l l o c a t i o n costs are p r i m a r i l y incurred by those  83 firms that maintain warehouses or depots, and hence are considered function of the firm's d i s t r i b u t i o n p o l i c y .  to be a  Firms with i n d i r e c t channels of  d i s t r i b u t i o n u t i l i z e wholesaler's f a c i l i t i e s and therefore incur fewer storage and a l l o c a t i o n costs.  On the other hand, firms with d i r e c t channels  maintain depots i n strategic locations across Canada and as a r e s u l t incur s u b s t a n t i a l l y higher storage and a l l o c a t i o n costs, c)  Transportation  Costs  Extensive transportation costs are incurred within the e t h i c a l pharmaceutical industry as most firms prepay these costs on the shipment of t h e i r products.  These costs, for the most part, constitute value contributed,  since the tasks of transportation are performed by f a c i l i t a t i n g However, some transportation costs may firms operate t h e i r own  be considered  agencies.  to be value added, i f  d e l i v e r y service at either t h e i r shipping department  or depots. TABLE VIII CLASSIFICATION OF DISTRIBUTION COSTS INTO VALUE ADDED AND VALUE CONTRIBUTED  D i s t r i b u t i o n Task  Value Added Component  Value Contributed  Component  Sorting Out and Accumulation  Labour including supervisors. Depreciation expense on equipment & buildings  Materials-shipping cartons Insurance Lease expense U t i l i t i e s & O f f i c e supplies  Storage and A l l o c a t i o n  Labour Depreciation  expense  Materials, insurance, lease expense, u t i l i t i e s , o f f i c e supplies.  Labour Depreciation  expense  Transportation  Outgoing f r e i g h t , express & postage Contract cartage lease expense  84 2.  Promotional Costs Promotional costs comprise the costs o f u t i l i z i n g the f i v e promotion-  a l elements;  personal s e l l i n g , journal advertising, d i r e c t mail, sampling arid  public r e l a t i o n s . The c l a s s i f i c a t i o n o f each element's costs into i t s value added and value contributed components i s shown i n Table IX. TABLE IX CLASSIFICATION OF PROMOTIONAL COSTS INTO VALUE ADDED AND VALUE CONTRIBUTED Promotional Element Personal  selling  Value Added Salaries & commissions Depreciation expense on cars and equipment  Value Contributed L i v i n g and t r a v e l l i n g expense Special meetings Lease expense on cars, etc.  Journal Advertising and Direct Mail  Materials, postage Advertising agency expense, Lease expense - computor  Sampling  Cost o f samples, postage, Package costs Lease expense - computor  Public Relations  Preparation and d i s t r i b u t i o n of f i l m s , materials, p e r i o dicals Postage Symposia costs, exhibits  The value added cost components, i n a l l but the personal s e l l i n g promotional element, consist p r i m a r i l y o f head o f f i c e wages and are included within the administration costs 3.  Administration Costs Administration Costs consist o f those costs associated with manage-  ment and s t a f f services, head o f f i c e salaries and market research.  The c l a s s -  i f i c a t i o n o f these costs into value added or value contributed i s shown i n Table X.  85 TABLE X CLASSIFICATION OF ADMINISTRATION COSTS INTO VALUE ADDED AND VALUE CONTRIBUTED Value Added  Value Contributed  Head o f f i c e s a l a r i e s f o r product, p r i c i n g , d i s t r i b u t i o n , promotion, market research and marketing management  4.  O f f i c e supplies O f f i c e equipment  Calculation of the Marketing Department's Economic Output The economic output of a firm's marketing department may be c a l c u l a t -  ed either by aggregating the value added cost components of a l l the marketing functions, or conversely, by subtracting the aggregate value contributed cost components of a l l the firm's departments from the t o t a l net revenue. The residual d o l l a r amount, i n the l a t t e r method, contains both the marketing department's t o t a l value added and the firm's gross p r o f i t .  The economic  output o f the manufacturing firm's marketing department i s then calculated by the removal, from t h i s residual amount, o f those p r o f i t s resulting from the a c t i v i t i e s of the non-marketing departments.  This procedure i s outlined  i n Table XI. B.  Selection of the Marketing Department's Unit Measures o f Economic Input The inputs f o r a manufacturing firm's marketing department  include:  labour, c a p i t a l , management "know-how", and manufactured products.  A suitable  quantitative measurement has not yet been developed f o r the unit input of management "know-how*. 1.  Consequently, only three input measures have been selected.  Man-hours of Labour: t h i s measure i s determined by multiplying the number of f u l l - t i m e marketing employees by the number of annual hours they have worked.  86 TABLE XI CALCULATION OF THE MARKETING DEPARTMENT'S ECONOMIC OUTPUT Total revenue from the sale o f e t h i c a l pharmaceutical Less:  other income Federal sales tax  products  $.  $ ______  Total net revenue  $.  Less:  Value contributed (non-marketing departments): Cost of goods sold $ R and D. i Royalties ______ General administration Interest expense ________ $ Less: Value contributed (marketing department): D i s t r i b u t i o n Function: Sorting out and Accumulation $ Storage and A l l o c a t i o n _____ Transportation _______ Promotion Function: Personal S e l l i n g ________ Journal, advertising _______ Direct Mail Sampling _______ Public Relations Administration Function ______ $ T o t a l Value Contributed a l l departments  $.  The marketing value added and the firm's p r o f i t s  $.  Less:  P r o f i t s contributed by the non-marketing departments  The Department's Economic Output ( t o tmarketing a l value added plus marketing's p r o f i t contribution)  2.  D o l l a r value o f the t o t a l marketing assets:  $. $.  t h i s input measure re-  f e r s to the c a p i t a l that has been invested i n marketing assets. I t i s measured by the d o l l a r value of the depreciated assets used i n the performance of the marketing functions. 3.  D o l l a r value o f the product input:  t h i s input measure refers to the  annual volume o f manufactured products that have passed through the  8 7  marketing department.  I t i s measured by the d o l l a r value of the cost  of the goods sold, adjusted by inventory changes within the marketing department. C.  Determination of the Marketing Department's Productivity Measures A marketing p r o d u c t i v i t y measure f o r the firms and the P.M.A.C. i s  determined f o r each of the three inputs by the c a l c u l a t i o n of the  respective  p r o d u c t i v i t y r a t i o , that i s , each firm's value added i s divided i n turn by i t s input measure.  A scale of e f f i c i e n c y r e s u l t s by ranking the firms' simi-  l a r l y determined p r o d u c t i v i t y measures. A.C.  This scale i s compared with the  P.M.-  standard i n order to determine what l e v e l on the scale i s judged e f f i c i e n t . Ill  A DESCRIPTIVE APPLICATION OF PRODUCTIVITY THEORY TO PHARMACEUTICAL FIRMS' MARKETING DEPARTMENTS  Complications are encountered i n the application of productivity theory to the firms' marketing departments i n a r e a l world s i t u a t i o n . of cost information  i s l i m i t e d to those date published  and shown i n Appendix I.  The  source  by the Harley Report^  Attempts to upgrade the q u a l i t y of these data were  not f r u i t f u l , as most firms did not respond to requests f o r additional or  2 more detailed cost disclosure. In some firms' income statements the breakdown of costs was sented as a percentage of sales.  only pre-  These firms had to be eliminated from the  analysis, since the c a l c u l a t i o n of value added i s based upon d o l l a r f i g u r e s . As a r e s u l t , p r o d u c t i v i t y measures can only be calculated f o r Firms A.B.E, and  F.  H.C.Harley, Drug Costs and P r i c e s . Minutes and Proceedings. (Queen's Printers:Ottawa,I966),p.348,600,824,833,924,1020 and 1066.  o cost  However, both Firms B and F responded to the request f o r more detailed information.  88 Another complication i s that t r a d i t i o n a l accounting practices have not been concerned with p r o d u c t i v i t y measurement and as a consequence, accountants do not d i s t i n g u i s h between the various department's value added and value contributed costs.  As a result of these complications, modifications become  necessary to the normative approach outlined i n Tables VIII to XI, A.  Quantitative Measurement of the Marketing Department's Economic Output The marketing department's economic output i s determined by the calcu-  l a t i o n of each firm's value added i n d o l l a r s , as shown i n Table XII. The value added measure f o r the firm's studied was  Firm A  $1,715,700  Firm B  1,867,944  Firm C  928,180  Firm F  1,773,415  as follows:  The calcuation of these figures i s based upon c e r t a i n suppositions regarding the d i v i s i o n of the cost of performing  the marketing functions into the value  added and value contributed cost components. 1.  D i s t r i b u t i o n Costs D i s t r i b u t i o n costs were not broken down into the costs of performing  the i n d i v i d u a l d i s t r i b u t i o n tasks, and as a r e s u l t the aggregate d i s t r i b u t i o n figure had to be c l a s s i f i e d either as value added or as value contributed. This decision was based upon the i n d i v i d u a l firm's d i s t r i b u t i o n p o l i c y .  Firm  E had a p o l i c y of i n d i r e c t d i s t r i b u t i o n and as a r e s u l t i t s costs were considered to be more accurately represented by the value contributed c l a s s i f i c a tions.  In contrast, Firms A,B  and F had d i r e c t d i s t r i b u t i o n p o l i c i e s ,  and  t h e i r costs were considered to be more accurately represented by the value added c l a s s i f i c a t i o n .  Eighteen of the f i f t y - s e v e n members (31 percent) of  89 TABLE XII CALCULATION OF THE VALUE ADDED OUTPUT OF PHARMACEUTICAL FIRM'S MARKETING DEPARTMENT  Firm A T o t a l Revenue Less: Federal sales Tax Foreign sales Discounts  Net Revenue  $10,500,000  Less:Value Contribu'i ied (non-marketing) Cost of goods sold 3,496,500 R and D 1,008,000 Royalties 462,000 General administration 903,000 Interest expense Proprietary marketing Inter-Company service charge Income taxes 987.000  Firm B  Firm E  $9,444,757  (.10,797,000  546,522  791,000 1,325,780  20.606 $8,877,629  $7,326,000  $8,680,220  4,486,660  1,175,000 534,000  2,590,000 720,458  35,399,032 7,119,529 3,367.893  395,927  534,ooo  1,085,028  11,586,050 309,435  $110,465,396  834,100 763.859 8.115.632 $3,520,875 $ 46,441,199  198,000 384,300 281,612 217,800 115.500 89,381 67,400 52,500 329,200 34,119 294,000 174,981 98,600 157.500 512.875 350,300 $2,639,700 $2,254,074 $1,654,600 386.130 924.000 783.000  2,637,686 4,970,942 348,945 234,366 2,209,308 60,761 2,319,773 234,366 3,434,427 138.884 2.430.239 $2,503,553 $ 28,448,824 9.900.248 730,138  $1,715,700 $1,867,944  $1,773,415  648.000 $3,347,042  Less:Value Contributed (marketing) Distribution Personal s e l l i n g Jr.advertising D i r e c t mail Samples Public relations  VALUE ADDED  P.M.A.C.  500,000 824.000 $2,915,900  $3,643,500  Less P r o f i t s  Firm F  $  871.600  $ 18,548, 576  the P.M.1A.C. had d i r e c t channels of d i s t r i b u t i o n , and as a r e s u l t 62 percent of i t s aggregate d i s t r i b u t i o n costs ($2,637,686) was considered to be value contributed.  90 This method of c l a s s i f y i n g the value added and value contributed d i s t r i b u t i o n cost components i s not without error.  The value added realized  by Firm E i n the performance of i t s sorting out and accumulation tasks i s considered to be value contributed.  Conversely, the value contributed r e a l -  ized by Firms A. B and F i n the performance of t h e i r d i s t r i b u t i o n tasks i s considered to be value added.  Nevertheless, i t i s expected that these errors  are o f such a minor nature that they w i l l not a l t e r , to any appreciable extent, the f i n a l results o f t h i s analysis. 2.  Promotion Costs Only one modification was necessary to the normative c l a s s i f i c a t i o n  of promotional costs shown i n Table IX.  Data were not available to permit  the exact d i v i s i o n of personal s e l l i n g costs into i t s value added and value contributed components. Firms B and E  divided t h e i r personal s e l l i n g costs into  travel  expenses and s a l a r i e s . This d i v i s i o n approximates the normative c l a s s i f i c a t i o n , except f o r the depreciation expense.  Since most firms lease t h e i r  automobiles, depreciation expense should be very minor, and as a r e s u l t there should be l i t t l e f a u l t with c l a s s i f y i n g salaries and t r a v e l expense as the t o t a l personal s e l l i n g value added and value contributed cost components. The P.M.A.C. and Firms A and F did not provide any information on the composition o f t h e i r t o t a l personal s e l l i n g costs.  Since these costs are  composed o f both value added and value contributed, they w i l l have to be a r b i t r a r i l y divided into these two component parts as an i n i t i a l procedure to determine the economic output. used f o r Firms B and E Consequently,  This d i v i s i o n must be consistent with that  and s t i l l approximate the normative c l a s s i f i c a t i o n .  i t i s based upon the P.M.A.C. average percentage  composition  91 that salary, car and t r a v e l expenses are of t o t a l personal s e l l i n g costs. P.M.A.C. averages-^ showed that f o r t y - f i v e e t h i c a l pharmaceutical firms spent 30 percent o f t h e i r personal s e l l i n g costs on travel and car expenses, and 70 percent on s a l a r i e s and commissions.  Firm B spent 30.7 percent** on t r a -  v e l and car expenses and i t had similar d i s t r i b u t i o n and personal s e l l i n g p o l i c i e s to both Firms A and F. Hence i t was f e l t that the P.M.A.C. average of 30 percent was a good a r b i t r a r y d i v i s i o n o f the personal s e l l i n g costs into value added and value contributed, and i t was consistent with Firms B and E as well as approximating 3.  the normative c l a s s i f i c a t i o n .  Administration Costs Administration costs were only available on an aggregate basis. In  order to simulate the normative c l a s s i f i c a t i o n of these costs i n Table X, they were considered to be value added. B.  Quantitative Measurement of the Marketing Department's Economic Input Three input measures were chosen to be representative of the marketing  department's economic input. 1.  Man-hours of Labour The quantitative value of the man-hours of labour input i s shown i n  Table XIII. These input measures w i l l be used i n l a t e r calculations to determine the e f f i c i e n c y o f the i n d i v i d u a l firm's sales force. C. Harley, Drug Cost and P r i c e s . Minutes o f Proceedings and Evidence (Queen's P r i n t e r : Ottawa, 1966) p. 3^5. Average gross compensation o f a detailman to h i s firm was $7,4-58; h i s average expense account and cost of his car was $1,599 and $1,653« Hence the average annual cost of a d e t a i l -  man was $10,710.  ^ b i d . . p. 1066.  92 TABLE XIII CALCULATION OF THE MAN-HOURS OF LABOUR INPUT Firm  Size o f Sales Force  P.M.A.C.  1,540  Number o f Annual Hours Worked  5  Man-hours of Labour Input Measure  2,000  3,080,000  Firm A  80  2,000  160,000  Firm B  92  2,000  184,000  Firm E  35  2,000  70,000  Firm F  90  2,000  180,000  2.  The Dollar Value o f Total Marketing Assets Input Measure The t o t a l marketing asset input measure as shown i n Table XIV w i l l  be used to calculate the e f f i c i e n c y with which firms u t i l i z e their marketing assets.  This measure also gives an i n d i c a t i o n o f the degree of mechaniza-  tion o f the marketing department and i t s p r o d u c t i v i t y measure i s expected to have an inverse r e l a t i o n s h i p with the labour p r o d u c t i v i t y measure.  0  The asset input measure could not be determined as r e a d i l y nor as objectively as the labour input measure. segregated  Firm A's marketing assets were not  from the general company's assets and hence t h i s input measure  was not determinable.  Firm E used i t s marketing assets i n the marketing o f  those assets used exclusively f o r e t h i c a l products would be too subjective to be meaningful.  The P.M.A.C. asset average was not broken down into  The source of t h i s information i s Table X, Chapter 4, page 343 o f the Harley Report. The sales force r e f e r s to the t o t a l number o f f u l l time d e t a i l men and t h e i r supervisors employed by each firm. The number of annual hours worked i s based upon a 40 hour work week and a 50 week work year. °This inverse relationship between the p r o d u c t i v i t y of labour and assets results from the trade-off of these inputs due to the s c a r c i t y of investment c a p i t a l and the mutually exclusive nature of the inputs. 5  93 marketing assets.  Only Firms B and F provided s u f f i c i e n t information to  permit the c a l c u l a t i o n o f t h e i r asset input measures. TABLE XIV CALCULATION OF THE MARKETING ASSET INPUT MEASURE  7  Type o f Asset Branch o f f i c e & warehouse Company automobiles  Firm B  $ 1,063,725 leased  Firm F  $ 156,000 160,000  Other f i e l d sales equipment  —  15,000  Head o f f i c e equipment  30,000  25,000  $ 1,093,725  $ 356,000  marketing  Delivery trucks Total Marketing 3.  Assets  Dollar Value o f the Product Input Measure The product input measure i s used to calculate the e f f i c i e n c y  with which the marketing department markets t h e i r products.  I t should be  determined by adjusting the d o l l a r value of the cost of goods sold, to the difference between the beginning and ending marketing inventory l e v e l s . However, information was not available on inventory changes, and as a r e s u l t the value of the cost of goods sold was used to represent t h i s input measure, and i s shown i n Table XV. TABLE XV CALCULATION OF THE PRODUCT INPUT MEASURE  1  P.M.A.C. FIRM B FIRM E FIRM F FIRM A Dollar value o f the cost o f goods sold $35,399,032 $3,496,500 $4,486,660 $1,175,000 $2,590,000 ?This information was obtained from personal  correspondence.  ^This information was obtained from Table XI of t h i s Chapter. Firm F's value i s non-comparable to the extent that i t does not contain manufacturing administration costs.  94 C. The C a l c u l a t i o n o f the Marketing Department's P r o d u c t i v i t y Measurements The c a l c u l a t i o n o f the marketing department's p r o d u c t i v i t y measurements i s shown i n Table XVI, and t h e i r ranked order o f e f f i c i e n c y i s shown i n TABLE XVI CALCULATION OF THE MARKETING DEPARTMENT'S PRODUCTIVITY MEASUREMENTS Value Added Man-Hours of Labour Input Firm A  160,000 -  Firm B  $1,867,944 184,000 "  Firm E  $  Firm F P.M.A.C. (Standard)  871,600 _ 70,000 "  x  1  v  ,  0  Value Added Product Input  Value Added Marketing Assets  9  $1,715,700 $3,496,500  f  1  $1,867,944 $1,093,725  5 D  '  1  =  $ 871,600 _ $1,175,000 -  $18,548,576 3,080,000 "  6.05  5  9  v , f  *  c  f ,773,415 _ 0.686$2,590,000  $1,773,^15 4.98 $ 356,000 " y  $18,548,^76 _ $35,399,032 =  0  4  1  4  9.8  >  n  x  $1,773,415 180,000  0  u  '^5  Table XVII. Firm E has the highest p r o d u c t i v i t y measures f o r both the manhours o f labour (12.45) and the volume o f products input (0.742). TABLE XVII RANKED ORDER OF MARKETING EFFICIENCY FOR THE PRODUCTIVITY MEASURES Ranked Order 1 2 3 4 5  Man-hours o f Labour Firm E Firm A Firm B Firm F Standard  Marketing Assets Firm F Firm B  Product Input Firm E Firm F Standard Firm A Firm B  ^Firm F's p r o d u c t i v i t y measure f o r the product input should a c t u a l l y be lower than 0.686. The d o l l a r value o f i t s cost o f goods sold ($2,590,000) d i d not include manufacturing administration costs.  95 IV.  THE INTERPRETATION OF THE MARKETING DEPARTMENT'S PRODUCTIVITY MEASURES  The interpretation of the marketing department's p r o d u c t i v i t y measures i s f a c i l i t a t e d by r e f e r r i n g back to Table XVII, which i l l u s t r a t e d the ranked order of e f f i c i e n c y f o r each firm's p r o d u c t i v i t y measures. The man-hour of labour productivity measure was  highest for Firm E.  This means that Firm E has the most e f f i c i e n t f i e l d sales force, as the average man-hour r e s u l t s i n more value added than does the average man-hour for any other firm.  The standard productivity measures r e f l e c t the average  a c t i v i t i e s of 41 e t h i c a l pharmaceutical firms.  I t i s against these measures  that s i m i l a r p r o d u c t i v i t y measures of i n d i v i d u a l firms are to be compared and evaluated.  A l l four firms had higher productivity measures than the  Standard (the P.M.A.C. 6.05)  and i t may  be interpreted that they were more  e f f i c i e n t than the average pharmaceutical firm.  However, due to the  ex-  treme v a r i a t i o n i n the magnitude of this productivity measure between the Standard and Firm E (6.05  as compared to 12.45) doubt i s cast as to the v a l -  i d i t y of the Standard's labour productivity measure.^ Marketing asset productivity measures were only determinable f o r Firms B and F.  They indicate that Firm F added $4.98 of value added for each  d o l l a r that was $1.71  and was,  invested i n marketing assets,^" whereas Firm B added only therefore, l e s s e f f i c i e n t .  The  expected inverse relationship  between the labour and asset productivity measures appears to be substanl^Considerably l e s s v a r i a t i o n i s noted i n the magnitude of the product input p r o d u c t i v i t y measure between the standard and other firms. Since the value added i s common to both productivity measures, the annual number of manhours worked may be i n error. However, i t i s possible that the Standard's p r o d u c t i v i t y measure i s correct and that the industry i s characterised by a wide v a r i a t i o n i n the p r o d u c t i v i t y of t h e i r sales force. n  This  refers to the depreciated  value of the marketing assets.  96 tiated.  Firm B had a higher labour productivity measure than Firm F, as a  r e s u l t of i t s smaller investment i n i t s f i e l d sales force r e l a t i v e to the size of i t s value added.  Conversely, Firm B had a lower asset productivity  measure than Firm F, as a r e s u l t of i t s greater investment i n marketing assets. The product input productivity measure was highest f o r Firm E.  For  every d o l l a r value o f product that passed through Firm E's marketing department $.74 was added to the firm's economic output. with $.52  f o r the Standard and $.42  f o r Firm B.  This may be compared  Firms E and F appear to be  more e f f i c i e n t i n the marketing of t h e i r products than the Standard, while Firms A and B are l e s s e f f i c i e n t . The pharmaceutical firm with the most e f f i c i e n t marketing department should not be determined by the interpretation of any one productivity measure; rather, a l l productivity measure should be taken into consideration.  This should involve an aggregation of each firm's productivity  measures on a weighted basis, i n accordance with their r e l a t i v e importance. The most e f f i c i e n t firm would then have the l a r g e s t aggregated productivity measure.  However, the assignment of optimal weights i s a subjective matter  that p r o d u c t i v i t y theorists have not as yet resolved, not have a common u n i t f o r aggregative purposes.  and the measures do  Consequently, the product  input p r o d u c t i v i t y measure i s used as the basis f o r judging the firm with the most e f f i c i e n t marketing department,  since t h i s measure i s the most  comprehensive p r o d u c t i v i t y measure determined i n t h i s analysis.  Firm E  has the most e f f i c i e n t marketing department followed by Firms F, A and B. V.  SUMMARY  The application of productivity theory to the marketing departments of  97 various pharmaceutical manufacturing firms was undertaken from both a normative and a d e s c r i p t i v e approach.  The normative approach outlined the  procedures f o r c a l c u l a t i n g value added and selected the most appropriate unit measures of economic input.  The actual implementation o f the produc-  t i v i t y theory under the descriptive approach required that certain modifications be made to the normative approach.  These were of a minor nature  and would not a l t e r the v a l i d i t y of the f i n a l results to any appreciable extent. Three p r o d u c t i v i t y measures were calculated for each firm's marketing department, by dividing i t s value added by each of i t s three input measures. Firm E was the most e f f i c i e n t i n the use o f both i t s sales force and i t s product inputs, while Firm F made the more e f f i c i e n t useof i t s marketing assets. The most e f f i c i e n t o v e r - a l l firm could not be determined by aggregating the i n d i v i d u a l p r o d u c t i v i t y measures, due to the lack of a common u n i t o f measurement and an appropriate weighting system.  Consequently, the product  input p r o d u c t i v i t y measure was used as the basis f o r judging the firm with the most e f f i c i e n t marketing department.  Firm E was the most e f f i c i e n t ,  followed by Firm F, the Standard, and Firms A and B.  CHAPTER VI SUMMARY AND CONCLUSIONS C r i t i c i s m l e v i e d against pharmaceutical marketing costs has been more concerned with the absolute s i z e of these costs, rather than with the effectiveness with which marketing funds have been employed.  This thesis  has endeavoured to determine the effectiveness o f six pharmaceutical firms* marketing departments i n r e l a t i o n to t h e i r marketing p o l i c i e s and the costs incurred i n the implementation o f these p o l i c i e s .  This effectiveness has  been measured by two methods: (1) a r a t i o of each firm's rate o f return to the l e v e l of i t s marketing costs, and (2) a p r o d u c t i v i t y r a t i o that permits the calculation o f r e l a t i v e e f f i c i e n c i e s .  The r e s u l t s o f each method are  expressed i n a ranked order o f effectiveness and are then compared, i n Table XVIII, f o r the consistency o f each firm's ranking. TABLE XVIII COMPARISON OF THE RANKED ORDERS OF EFFECTIVENESS' Ranked Order o f Effectiveness  Method o f Measurement Ratio of the Rate of Productivity Measure Return to the Level For the Product Of Marketing Costs Input  Marketing Policies  1  Firm D  0.95  2  Firm E  0.83  Firm E  .74  3  Firm A  0.7  Firm F  .69  4  Firm F  0.53  Standard (PMAC)  .53  /  5  Standard (PMAC)  0.5  Firm A  .49  Wid emphasis jDirect channels ion personal  6  Firm C  0.41  Firm B  7  Firm B  0.35  .42  l l n d i r e c t channels and emphajsis on mass Jselling  /selling  1  ^This Table i s a combination o f I l l u s t r a t i o n 14 i n Chapter IV and Table XVI i n Chapter V.  99 P r o d u c t i v i t y measures could not be determined f o r Firms D and C, but f o r the other f i r m s , the general order of ranking i s c o n s i s t e n t between the two methods of measurement.  The order of e f f e c t i v e n e s s f o r Firms F and A  has been reversed with the p r o d u c t i v i t y method of measurement, however, since the p r o d u c t i v i t y measure f o r Firm F i s higher than i t should be (as explained i n Footnote 7 i n Chapter V), t h i s change i n order i s not considered to be s e r i o u s . There also appears to be a c o n s i s t e n t r e l a t i o n s h i p between the adopted marketing p o l i c i e s and the ranked order of effectiveness.  Firms D and E  use i n d i r e c t channels of d i s t r i b u t i o n and emphasize mass s e l l i n g promotional methods, and t h e i r marketing departments rank high i n t h e i r order of e f f e c tiveness.  This may be contrasted with the other firms t h a t use d i r e c t  channels of d i s t r i b u t i o n and emphasize personal s e l l i n g , and t h e i r marketing departments rank lower i n e f f e c t i v e n e s s .  On the b a s i s of the consistencies  i n Table X V I I I , i t i s p o s s i b l e to s t a t e the following conclusions: Conclusion 1 There i s a wide degree of variance between the i n d i v i d u a l firm's marketing e f f e c t i v e n e s s . Explanation:  the p r o d u c t i v i t y measures vary from Firm E (.74). to  Firm B (.42), while the measures from the other method v a r y from Firm D  (.95)  to Firm B  (.35).  Conclusion 2 Firms D and E may be regarded as having the most e f f i c i e n t marketing departments, w h i l e Firms C and B have the l e a s t e f f i c i e n t marketing departments.  100 Explanation:  Although p r o d u c t i v i t y measures could not be determined  for Firms D and C, i t i s assumed that they would r e t a i n t h e i r r e l a t i v e ranked positions i n the event that these measures could be determined.  This assumption i s based on the consistency of  the firms* r e l a t i v e ranked positions f o r both methods of measurement.  Firms D and E consistently rank the highest, while Firms C  and B are the lowest. Conclusion 3 I t would appear that firms who adopted an i n d i r e c t d i s t r i b u t i o n p o l i c y and a promotional p o l i c y that emphasized mass s e l l i n g methods had a more e f f i c i e n t marketing department. Explanation; These marketing p o l i c i e s are a primary method of d i s tinguishing between the firms i n t h i s study, and a high l e v e l of marketing e f f i c i e n c y i s associated with t h e i r  implementation.  Conclusion 4 The p r a c t i c e of d e t a i l i n g has resulted i n the pharmaceutical industry incurring the highest l e v e l of marketing costs o f those industries studied. Explanation: Marketing costs may best be compared between the firms i n the soap and t o i l e t r y industry and those i n the pharmaceutical i n dustry, since these firms appear to operate within a s i m i l a r market structure, namely, a d i f f e r e n t i a t e d oligopoly.  The P.M.A.C. spent  33 percent of i t s sales on marketing, while between 23-30 percent was spent by the soap and t o i l e t r y firms.  Pharmaceutical firms  spent s u b s t a n t i a l l y larger amounts on personal s e l l i n g (15 percent as compared to between 2.3 to 7.2 percent), but smaller amounts on  101 mass s e l l i n g elements than these other firms (10.2 percent as compared to between 14.7 to 17.3 percent).  This may be the r e s u l t  of both the complex nature of the product, and the presence of l e g i s l a t i o n that p r o h i b i t s d i r e c t advertising to the consumer. Conclusion 5 The absolute l e v e l of marketing ciency of a firm's marketing of return to the marketing  costs i s a poor i n d i c a t o r of the e f f i -  department, whereas, both the r a t i o of the rate  costs and the productivity r a t i o appear to give  consistent r e s u l t s i n evaluating performance. Explanation:  A comparison between the l e v e l o f a firm's marketing  costs and the calculated effectiveness of i t s marketing  depart-  ment i s shown i n Table XVIX and there appears to be no meaningful relationship between these two f a c t o r s . TABLE XVIX COMPARISON'."BETWEEN THE EFFECTIVENESS OF THE MARKETING DEPARTMENT AND THE SIZE OF THE MARKETING COSTS Ranked Order  1 2. 3  4  5 6  7  Level o f Effectiveness of the Marketing Department determined by Marketing Ratio of rate of return to Productivity ratio costs Marketing costs _ Firm D Firm C (392) Firm E Firm E Firm E (33.6$) Firm A Firm F Firm B (33.2$) Standard (33$) Firm F Standard Standard Firm A Firm F (32.2$) Firm C Firm B Firm A (25.9?) Firm B Firm E (21$) Consequently,  government intervention that l i m i t s the maximum s i z e  o f marketing  costs, may reduce wastage that can be associated with  the ineffectiveness o f Firms B and C. but a t the same time i t may reduce the effectiveness o f the more e f f i c i e n t firms.  102 Conclusion 6 Perhaps the Canadian government would be more successful i n reducing the cost of medication i f pharmaceutical firms were encouraged to undergo p r o d u c t i v i t y measurement, with the aim of upgrading the q u a l i t y of marketing performance, and i f more meaningful marketing standards of comparison were established f o r d i f f e r e n t industries. RECOMMENDATIONS FOR FURTHER STUDY A.  Enlarging the Scope of the Study The previous conclusions r e f e r to the s p e c i f i c a c t i v i t i e s of the s i x  pharmaceutical firms f o r  19°5  only  and generalizations expanded to include  more firms at any point i n time would not be v a l i d .  In order to develop  such desirable generalizations, the scope of the study must be enlarged. A larger number of firms must be involved over a longer period of time.  In  order to t e s t the v a l i d i t y of the hypothesis, that firms with i n d i r e c t channels of d i s t r i b u t i o n and emphasis upon mass s e l l i n g methods are more e f f i cient than firms with d i r e c t channels of d i s t r i b u t i o n with emphasis upon personal s e l l i n g , i t would be necessary to ensure that the p a r t i c i p a t i n g firms were evenly d i s t r i b u t e d around this p o l i c y issue. B.  Development o f Standards Within the Industry The Standard used i n t h i s study represents an average of the a c t i v i t i e s  of forty-one e t h i c a l pharmaceutical firms.  These firms d i f f e r i n :  the  l e v e l of t h e i r marketing costs; t h e i r marketing p o l i c i e s ; and i n the effectiveness with which these p o l i c i e s are implemented.  As a r e s u l t , the aver-  aging out process moves the Standard from a theoretical p o s i t i o n of o p t i mality to one of an averaged effectiveness.  Consequently, the f a c t that  Firms D and E are ranked higher than the Standard does not answer the v i t a l  103 questions of (1) How good i s t h e i r ranked positions r e l a t i v e to the optimum? and (2) How much better might these firms become? The upgrading o f the q u a l i t y of the Standard l i e s beyond the scope o f t h i s thesis and awaits future studies f o r further development.  But i t  would appear that the Standard would be more meaningful the more c l o s e l y i t s p o l i c i e s and a c t i v i t i e s are representative of the firms with which i t i s being compared.  Consequently, a Standard that i s the average o f only those  firms with s i m i l a r marketing p o l i c i e s may be more useful than the Standard used i n t h i s t h e s i s . C.  Development o f Standards i n Other Manufacturing Industries Marketing p r o d u c t i v i t y Standards should be developed as a means of  evaluating the performance i n other manufacturing industries.  This w i l l  permit the ranking o f marketing e f f i c i e n c y f o r the d i f f e r e n t industries and the i d e n t i f i c a t i o n of those industries whose performance i s below Standard and r e f l e c t s wastage.  Consequently, the focus o f attention w i l l be upon  upgrading the q u a l i t y o f performance of these industries, thereby benefiting society as a whole, rather than imposing r e s t r i c t i o n s on t h e i r a c t i v i t i e s that w i l l have the opposite e f f e c t .  B I B L I O G R A P H Y  105 A.  BOOKS  Anthony, R.N. Mana^msnf, A n o c m n t . i n - Test and Cases. Homewood, I l l i n o i s : Richard D. Irwin, Inc., I960. Brigham, E . F . and J . F . Weston. Managerial Finance. Second E d i t i o n . Toronto: Holt, Rinehart and Winston, Inc., I960. Buzzell, R.D. V _ _ A_d_ by Industrial D i s t r i b u t o r Ohio State University, 1959.  ___ Yh?ir Productivity.  C u l l i t o n , J.W. The Management of Marketing Costs. Boston:Harvard University,  1948.  ~  Dean, J o e l , Managerial Economics. Englewood C l i f f s , N.J.:Prentice-Hall, Inc., 1964. Duddy, E.A. and D.A. Revzan, Marketing:an I n s t i t u t i o n a l McGraw-Hill Book Company, 1953.  Approach.Toronto:  Gordon, J.M. and G. Shillinglaw. Accounting A Management Approach. Third E d i t i o n . Homewood, I l l i n o i s : R i c h a r d D. Irwin, Inc., 1964. Hendriksen, E.S. Accounting Theory. Homewood, I l l i n o i s : R i c h a r d D. Irwin, Inc., 1965. Howard, J . Marketing Management. Revised Edition. Homewood, I l l i n o i s : R i c h a r d D.Irwin, Inc., 1963. Kelley, and Brink. The Management of Promotion. Englewood C l i f f s , N.J.: Prentice-Hall, Inc., 1963. Kohler, E.L. jk Dictionary f o r Accountants. Englewood C l i f f s , N.J. PrenticeH a l l , Inc., 1963. Kotler, P. Marketing Management. Englewood C l i f f s , N.J. Prentice-Hall, Inc.,  1967.  Lazer Wm. and E.T.Kelley (ed.). Managerial Marketing P e r s p e c t i v e s and Viewpoints. Homewood, I l l i n o i s : R i c h a r d D. Irwin, Inc., 1962. Lazo, H. and A. Corbin. Management i n Marketing. Toronto:McGraw-Hill Book Company, 1961. Leftwich, Richard H. The Price System and Resource Allocation . Third Edition. Toronto:Holt, Rinehard and Winston, Inc., 1966. McCarthy, E.J. Basic Marketing A Managerial Approach. Homewood I l l i n o i s : Richard D. Irwin, Inc., 196%.  106 Peterson. Pharmaceutical S e l l i n g and Detailing. Toronto:McGraw-Hill Book Company, 1949. B.  GOVERNMENT PUBLICATIONS  Canadian Government, Special Joint Committee of the Senate and House of Commons, Consumer Credit. Minutes of Proceedings and Evidence, Ottawa: Queen's P r i n t e r s . Vols. 13,22 and 23. 1967. Department of National Health and Welfare. Royal Commission on Health Services. Provision, D i s t r i b u t i o n and Cost of Drugs i n Canada, Ottawa: Queen's P r i n t e r s , 1964. Dominion Bureau of S t a t i s t i c s . Manufacturers of Pharmaceuticals and Medicines. # 46-209. Ottawa: Queen's Printers, 1953,1960-65. Harley, H.C. "Drug Costs and Prices", Second (Final) Report of the Special Committee of the House of Commons. Ottawa: Queen's Printers, . "Drug Costs and P r i c e s , " Minutes of Proceedings and Evidence of the Special Committee of the House of Commons. F i r s t Session-Twentyseventh Parliament. Ottawa:Queen*s P r i n t e r s , 1966. R e s t r i c t i v e Trade Practices Commission Report. "Concerning the Manufacture, D i s t r i b u t i o n and Sale of Drugs," Ottawa:Queen's Printers, 1963. C.  PERIODICALS  Bauer, R.A. and M.G. F i e l d . "Ironic Contrast:U.S. and U.S.S.R. Drug Industries," Harvard Business Review, XL (Sept.-Oct.), 89-97. Chamberlin, E.H. "The D e f i n i t i o n of S e l l i n g Costs," The Review of Economic Studies. 315 8 5 : 5 9 . , January, 1964. Comanor, W.S. "Research and Competitive Product D i f f e r e n t i a t i o n i n the Pharmaceutical Industry i n the U.S.," Economica. 31:372-384, June 10,  1964.  , "U.S. Drug Industry-Pricing,"  Journal of Business. 39*12-18, January,  1966. Coons, Q.L. "Marketing's Challenge to Economics," 27:3:11, July, 1963.  Journal of Marketing,  Else, P.K. "The Incidence of Advertising i n Manufacturing Industries," Oxford Economic Papers. 18:1:88-110, March, 1966. Feber, R.A. "How to Measure Marketing Performance," Harvard Business Review, 43:3:132-142, May, 1965.  107 Ferber, R. "The Effectiveness of Pharmaceutical Advertising: A Case Study," Journal of Marketing. 4:398-407, A p r i l , 1958. Parker,, D.D. "Improved E f f i c i e n c y and Reduced Cost i n Marketing," Journal of Marketing. 26:2:15-21, A p r i l , 1962. Patterson, J.M.  "What are the S o c i a l and E t h i c a l Responsibilities of July,  1966.  Dun's Review. "The Ratios of Manufacturers," 90:5:78-80, November,  1967.  Marketing Executives?" Journal of Marketing.  , "The Ratios of Wholesalers,"  90:4:88,  30:12-15,  October,  I967.  , "The Ratios of R e t a i l e r s , " 90:6, December, 196?. Searl, R.0. and M. Pernarowski, "The Biopharmaceutical Properties of S o l i d Dosage Forms: I . An Evaluation of 23 Brands of Phenylbutazone Tablets," The Canadian Medical Association Journal. 96:1513-1520, June 10,1967. Staudt, T.A. "Program f o r Product D i v e r s i f i c a t i o n , " Harvard Business Review.  32:122, 1954.  Steele, H."Monopoly, and Competition i n the E t h i c a l Drugs Market," Journal of Law and Economics. 5:131-150, October, 1962. Wegner, W.V.  "Trends i n Pharmaceutical Advertising," Journal of Marketing.  24:3:65, January, i960. D.  UNPUBLISHED MATERIALS  B u z z e l l , R.D. "Productivity i n Marketing," Unpublished Doctorial D i s s e r t ation, The Ohio State University, 1957.  APPENDIX  109 INCOME STATEMENTS I. The P.M.A.C. The P.M.A.C. Income Statement For the Year Ending December 31, 1964 REVENUES Sales Other Revenue TOTAL REVENUE  $107,784,504 2.680.892  $110,465,396  EXPENSES Cost o f Goods sold R and D Royalties Admini s tra tion Interest Marketing Distribution Personal S e l l i n g J r . Advert!sing Direct Mail Sampling Public Relations Admini s t r a t i o n Income taxes  32.0 6.4 3.0 10.4 0.3 33.0 ( 3.8) (15.0) ( 2.0) ( 2.5) ( 3.5) ( 2.2) ( 4.0) 7.3  TOTAL EXPENSES AND TAXES NET PROFIT  35,399,032 7,119,529 3,367,893 11,586,050 309,435 4,254,333 16,569,809 2,209,308 2,319,773 3,434,427 8,115,632 4,418,616 8.115.632 102.438.522  9.0  $ 9.900.248  Source: H.c.Harley, Drug Cnntn and Prifififi. Minutes anfl Proceed. j.ngs, (Queen's Printers:Ottawa, 1967) pp.348-350.  110 II.  FIRM A Firm A Income Statement For the Year Ending December 3 1 . 1965 $10,500,000  NET REVENUE EXPENSES Cost of Goods Sold R and D Royalties General Administration Marketing Distribution Personal S e l l i n g J r . Advertising Direct Mail Sampling Public Relations Admini s t r a t i o n Income taxes NET PROFIT  33.3 9.6 4.4 8.6 25.9 ( 4.6) (12.2) (1.1) ( 0.5) ( 2.®) ( 1.5) ( 3.2) 9.4 8.8  3,496,500 1,008,000 462,000 903,000 483,000 1,281,060 115,500 52,500 294,000 157.500 336,000 987,000 $924,000  Source: H.C. Harley, Drug Costs and Prices, Minutes and Proceedings, (Queen's Printers:Ottawa, 1966) p.833. Additional information was obtained i n a personal interview with o f f i c i a l s of t h i s firm.  Ill I I I . FIRM B  Firm B Income Statement For the Year Ending December 31, 1965  $8,898,235  NET REVENUE EXPENSES Cost of Goods Sold General administration Marketing Distribution Personal S e l l i n g J r . Advertising Direct M a i l Sampling Public Relations Income taxes  *  50.5 4.4 33.2 (13.9) (10.3) ( l.o) ( 0.4) ( 1.9) ( 5.7) 7.3  $4,486,660 395,927 1,234,424 934,091 89.318 34,119 174,981 512,875 648.000  TOTAL EXPENSES NET PROFIT  $8.512.105 4.4  $  386.130  Source: H.C.Harley, Drug Costs and Prices. Minutes and Proceedings. (Queen's Printers:Ottawa, 1966) p.1066. IV.  FIRM C  Firm C Pharmaceutical Sales Dollar For the Year Ending December 31. 1965  Manufacturing and Quality Control Royalties R and D General Administration Marketing: Distribution 8.0 Personal s e l l i n g 19.0 J r . Advertising 1.7 Direct mail 1.3 Sampling 5.4 Public r e l a t i o n s 3.6 Income tax Net P r o f i t  32$ 5 '2 6 39  8  Source: H.C. Harley, Drug Costs and P r i c e s . Minutes and Proceedings. (Queen's Printers:Ottawa, 1966) p.600.  112 V.  FIRM D Firm D Income Statement For the Year Ending December 31. 1965  NET SALES  100$  EXPENSES Cost of Goods Sold R and D General administration Interest Marketing: Distribution (3.0) Personal s e l l i n g ( 7 . 5 ) J r . advertising (1.7) Direct mail (3.0) Sampling (3*6) Public relations(0.6) Administration (1.6) Income taxes  29$ 12 9 2 21  14  NET PROFIT  1_$  Source:H.C.Harley, Drug Costs and P r i c e s . Minutes and Proceedings. (Queen's Printers:Ottawa, 1966) p.824-5. VI-  FIRM E E t h i c a l Pharmaceutical Sales $5,771,800  NET REVENUE EXPENSES Marketing Distribution Personal s e l l i n g : Salaries Travel expenses J r . advertising Direct mail Samples Public r e l a t i o n s Administration TOTAL MARKETING EXPENSES  33.6$ (2.6)  $148,500  (5.5) (3.8) (1.2) (5.7) (1.7) (6.1) (7.0)  319,600 217,800 67,400 329,200 98,600 350,300 407.250 $1,939,325  Source: H.C. Harley, Drug Costs and Prices. Minutes and Proceedings. (Queen's Printers:Ottawa, 1966) pp.941-963.  Firm E Income Statement For the Year Ending December 31, 1965 REVENUES E t h i c a l sales Proprietary sales  $5,771,800 1.554.200 $7,326,000  TOTAL REVENUES EXPENSES $1,175,000 Cost o f goods sold 534,000 R and D 834,100 Proprietary marketing 534,000 General administration Inter-firm service charge 500,000 Marketing-*!' 7Distribution:* -ethical 148,500 -proprietary 49,500 Administration:* -ethical 407,250 -proprietary 135,750 1,382,900 P romo t i o n - e t h i c a l 824.000 Income taxes  16# 7.3 11.4 7.3 6.8 33.6  TOTAL EXPENSES AND TAXES  $6.543.000  NET EARNINGS  $  783.000  Source: H.C.Harley, Drug Costs and P r i c e s . Minutes and Proceedings. (Queen's Printers:Ottawa, 1966) pp.941-963. •This a l l o c a t i o n i s based upon the proprietary volume o f business amounting to approximately 25 percent of the firm's t o t a l business.  114 VII.  FIRM F Finn F Income Statement For the Year Ending December 31.  TOTAL REVENUE Less: Federal sales tax Non-domestic sales  1965  $10,797,000 $791,000 1.329.780  2.116.780  NET ETHICAL REVENUE EXPENSES Manufacturing 29. 8# R and D 8.3 General administration 12.5 Marketing: 32.2 Distribution (7.5) Administration (3.6) Personal s e l l i n g ( l 3 . 4 ) J r . advertising (2.7) Direct mail (0.7) Samples (2.7) Public relations (1.6) 8.8 Income taxes  $8,680,220 $2,590,000 720,458 1,085,028  651,016 312,488 1,163,149  234,366 60,761 234,366  138,884 730.138  TOTAL EXPENSES AND TAXES  $7.950.082  NET PROFIT  $  730.138  Source: H.C. Harley, Drug Costs and Prices. Minutes and Proceedings. (Queen's Printers:Ottawa, 1966) pp.1020-21.  

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