The Business Of
Healthcare | AbbVie | What Are Their Margins?
Morning All!
So, yesterday we dug into how AbbVie makes money. And we saw that AbbVie’s biggest drug is Humira, making up ~40% of revenues. We saw that the company’s biggest customer is McKesson - the drug wholesaler also making up ~40% of revenues. And we were introduced to the phenomenon of patent protection…
… which we’ll be diving into much deeper on Friday! But that’s enough with revenues. Today, let’s turn our attention to costs and look at what’s really necessary to make drugs! Let’s start with a split of AbbVie’s cost structure.
We can see that COGS (cost of goods sold), SG&A (selling, general and administrative) and R&D (research and development) costs make up pretty much all of AbbVie’s costs. And we’re going to break down each of those now. So, without further ado…!
Biologics - Bigger And Costlier!
So, when it comes to making drugs like Humira. What’s actually involved? Well, you may remember that in order to make Huel and Pepsi, we needed some raw materials. Well, for AbbVie, it’s kind of the same - we need some raw materials! And what’re the main ingredients AbbVie need to create Humira? Well, there’s a long list. Including adalimumab (the active substance), sodium citrate, and mannitol.
But let’s not get too technical! What is important to note is that Humira is a biologic drug. Whilst ‘normal’ drugs are made from chemical reactions. Biologic drugs are created from biological products. This article here explains the differences simply! But basically, biologic drugs require more complex equipment for their manufacture. The molecules are bigger than normal drugs. And they’re very temperature-sensitive!
And the sensitivity to temperature means a lot of money is spent to just store biologic drugs properly! But fortunately, AbbVie has plenty of space for their manufacturing processes and storage. The company has 14 manufacturing facilities worldwide which are used to create their ~30 drugs.
And so, if we take away the cost of raw materials. The cost of the specialised equipment. The cost of storage. And the cost of the employees (e.g. scientists) who help create the drugs. We get AbbVie’s gross margin! And the chart below shows us that the company has a pretty stellar margin of ~70%!
Now, 70% is super high. In fact, of all the companies we’ve looked at on TBO, only Ninety One - the asset manager - has a higher gross margin! But of course, what we’re really interested in is the EBIT margin. So, let’s look at the other costs involved and see if EBIT margins are as impressive!
GOAT Meets GOAT
Okay, so another cost we see for AbbVie is marketing costs. After all, what’s the point of making incredible drugs, that helps people with their conditions. If no one knows about them! So, how do drug manufacturers make people aware of their drugs like Humira?
Well, one way is similar to PepsiCo. We saw PepsiCo do loads of ads with celebrities. And would you believe it, drug manufacturers do that too! The image below gives us an example - the female tennis GOAT, Serena Williams, is advertising one of AbbVie’s drugs - Ubrelvy. Which helps cure migraines! But I should add that this isn’t common around the world. In fact, DTC advertising (where drug manufacturers advertise directly to consumers) is only legal in 2 countries… the US and New Zealand!
But there’s much, much more to marketing for a drug manufacturer than just celebrity ads. In fact, DTC advertising makes up a small % of AbbVie’s advertising budget. Because remember, all of AbbVie’s drugs need a prescription. These aren’t drugs like paracetamol where we can go and buy them from the supermarket!
And who gives out prescriptions? Doctors! They need to be aware of the drugs. So that they can then prescribe them for patients. And then these patients can go buy them from the pharmacy. And so, what do AbbVie do to make doctors aware of their drugs? All sorts! But one of the primary ways is by hiring sales reps who visit doctors and tell them all about the benefits of their drugs.
Now, these sales reps are expensive! But that’s not the only cost. Drug manufacturers pay doctors to speak about their drug products at dinner talks. They spend loads for ads in medical journals. And the highest % of advertising is spent on free samples!
Some reports suggest that over half of pharmaceutical advertising is in the form of free samples! And all these advertising tools are used with the intention of making their target audience - doctors - prescribe their products!
1 in 10,000 Isn’t The Best Odds!
Alright, so the final cost for AbbVie is R&D. And this is one of the most crucial costs for drug manufacturers. Because as we saw yesterday - and as we’ll see in more depth on Friday - patents for drugs expire. And when that happens, drug manufacturers need new drugs to make revenues for them!
Now, there’s 4 main steps in a R&D process. Let’s run through them very briefly!
Discovery: This is where AbbVie will look to understand a disease and try to identify molecules/compounds that can potentially impact that disease.
Pre-clinical testing: The molecule/compound is then tested in computer models and in animals to make sure it’s safe enough to test in humans. And this step in the process has faced many protests over the years…
Clinical testing: The molecule/compound is now ready to test on humans. And there’s 3 phases to clinical test. Phase 1 is a small trial on healthy volunteers. Phases 2 and 3 are larger trials on people who are affected by the condition!
FDA Review: The final stage is where the FDA (Food and Drug Administration) looks at all the data provided by AbbVie about the drug. And decides whether the drug should be allowed to be marketed and sold to people!
And even after approval, the FDA monitors the safety of the drug. Now, these steps all cost a fair amount! Because the laboratories used for testing need to be kitted out with very specialised equipment. And the volunteers taking part in these trials aren’t doing it for free!
Also, the chances of actually getting a molecule from Discovery to FDA Review are 1 in 10,000! And only 7.9% of Phase 1 drugs achieve FDA approval. Which means AbbVie need to trial loads of molecules at once! This article here is a nice, simple read about the regulatory approval process!
Lawsuits and Failed Acquisitions = Bumpy Margins!
Alright, so let’s wrap up by bringing all these costs together and looking at AbbVie’s margins. And in the chart below, you can see that whilst the company’s EBIT margin is nice and high ~31%. It’s very up and down! So, what’s going on here?
Well, when you see a company with fluctuating margins, but very consistent revenues (like we saw yesterday with AbbVie). Then it usually means one thing - the company’s had some one-off charges. Which are basically unexpected costs - not found in the normal course of operations. And that’s exactly what we see here with AbbVie!
In 2011, the drop in margin is because AbbVie had to pay $1.5bn due to unlawful promotion of one of their drugs. In 2014, the company had to pay $1.7bn to Shire after pulling out of their proposed acquisition. And in 2018, AbbVie took a $5bn impairment charge on their Rova-T drug. After realising that their acquisition in 2016 was a bit of a blunder! If we strip those costs out, then AbbVie’s margin picture would look at lot more stable!
28th Jun 2023
And that’s a wrap for today! I hope you enjoyed diving into AbbVie’s cost structure. Tomorrow we’ll look at how the US drug giant actually spends all its profits, and we’re in for a few surprises!
Have a fabulous day!
The Business Of Team