Tuesday, November 04, 2008

An Experiment: Ban All DTC Broadcast Advertising for One Year

At last week's "DTC in the Era of Consumer Choice" conference hosted by DTC Perspectives magazine, Hugh O'Neil, VP and Head of Market Access at Sanofi-Aventis, gave the audience a bit of a preview of PhRMA's new Guidelines for Direct-to-Consumer (DTC) Advertising.

It appears that PhRMA's members are likely to agree on a DTC advertising moratorium for newly approved drugs. O'Neil said there was a debate about the exact length of the moratorium -- whether it should be 6 months, one year, or longer. Bob Erhlich, chairperson, commented that most DTC campaigns do not begin until 6 months after launch anyway and a 6-month moratorium, therefore, would not be a change from current practices. Most people, therefore, expect PhRMA to recommend a 1-year moratorium.

What is often missing in the debate about DTC advertising and whether it should be banned or delayed 1 or more years is the contribution that DTC advertising makes to the overall Rx drug sales number and the drug industry's bottom line.

I got to thinking about about this when another presenter -- Dan Jaffe, Executive VP of Governmental Relations at the Association of National Advertisers -- said that a DTC moratorium could result in billions of lost sales. But would a moratorium hurt profits?

First, let's just get an idea of what the size of the US Rx drug market is in terms of annual sales.

According to the IMS Global Pharmaceutical and Therapy Forecast™ released last week by IMS Health, the U.S. pharmaceutical market, the world’s largest, is forecast to grow 1 - 2 percent to $287 - $297 billion, down from the 2 - 3 percent rate expected earlier this year. Contributing to the slower growth is less-than-expected demand for recently introduced products, as well as the economic climate, which appears to be having an impact on doctor visits and pharmaceutical sales.

From these numbers I calculate that currently the drug industry enjoys about $284 billion in sales of Rx drugs in the US per year. I recently saw from a chart in an oil industry PSA that the drug industry profit margin is about 20% (compared to 8% for the oil industry). Therefore, I calculate that the drug industry makes a profit of $57 billion on $284 billion in sales.

Against that, consider that the drug industry spends about $5 billion in DTC advertising. Assuming that the ROI for this spend is around 2.0, that means that DTC advertising drives about $10 billion in sales. That's 3.5% of the total sales in the US.

In other words, if DTC advertising were banned, US Rx sales would decrease to $274 billion. Using the the same 20% profit margin estimate, these sales would yield about $55 billion -- a loss of $2 billion in profit.

But the $5 billion saved by eliminating DTC could be added to the bottom line and more than offset this loss!

In light of this, it hardly seems worth all the bad publicity for the industry to save DTC. Pharma's bottom line would not be affected and could actually be higher if the $5 billion were spent on more effective types of promotion (via the Internet, for example).

What I propose is an experiment. Let's eliminate TV broadcast DTC advertising altogether for one year, but keep print and Internet-based DTC advertising. That is, no broadcast DTC for ANY drug, new or old.

Drug companies could pocket the money saved or spend it on print and Web promotions, which are not a target of DTC critics in Congress and elsewhere.

What do you think would happen?

Sure, TV networks that run DTC ads and agencies that produce the ads would lose money. But drug companies can do what they do in other parts of the world: produce disease awareness, non-branded TV ads. That would help keep TV and agency people employed.

Eventually, drug companies will have to shift spending away from TV anyway. According to Bob Erhlich, this is already happening, but at a snail's pace. Erhlich estimates that TV accounts for about 60% of the industry's DTC budget, down from 66% a few years ago. At that rate the industry won't reach 0% spending on TV DTC until 2040!

What the industry needs now is real change it can believe in!

Point of clarification: Tracy Staton of FiercePharma reported: "John Mack at the Pharma Market Blog puts a pencil to paper and finds that cutting DTC ads off television would save pharma $5 billion--and that savings would offset the resulting $2 billion hit to the industry's bottom line." (See "Do TV ads cost more than they're worth?").

Just to clarify: cutting all broadcast TV DTC advertising would save about $3 billion, not $5 billion. That's because TV represents about 60% of the average DTC budget (60% of $5 billion, which is the total ad spend on DTC per year for ALL brands, equals $3 billion; QED). Still, $3 billion added to the bottom line is enough to offset the $2 billion loss in profit if there were no TV ads. Actually, since there would still be DTC print and Internet advertising, the profit loss would be less than $2 billion.

Another way to do the analysis: If you cut $3 billion in TV spending from the DTC budget, sales might drop by $6 billion to $278 billion. That's a drop of $1.2 billion in profit (20% of $6 billion). The $3 billion in savings would more than make up for that loss.

11 comments:

  1. Anonymous2:22 PM

    Interesting theory. Problem is that you are using aggregates, and advertising decisions are made based on the ROI for that drug at that time. A moratorium would require consensus, and that is not likely to happen for a company that is realizing a beneficial ROI from its ads.

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  2. Of course this experiment would require a mandatory ban via legislative action of Congress.

    It would be a form of wealth redistribution! Those companies with negative ROI would benefit more than those with positive ROI. It's just like the case where homeowners who are under water because they borrowed more than their houses are worth benefit more from Bush's bailout than those whose home equity is more than enough to cover their mortgage debt.

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  3. Anonymous3:10 PM

    Sorry, but you can't assume that your profit margin remains the same when you take away spending that generates 2 to 1 revenue.

    Here's how you do this analysis:

    Assuming that the industry does have a 20% profit margin, it spends $227b to make $284b in sales. If you cut DTC, assuming a 2:1 ROI, the industry would spend $222b to make $274b.
    Industry margin with DTC: $57b
    Industry margin w/o DTC: $52b
    Marginal difference = $5b

    Thus, the marginal ROI is actually 1:1.

    This, of course, assumes only a short-term ROI. If you believe that DTC has a longer term effect due to lifetime value, the DTC investment pays off rather nicely over 2-3 years.

    If you agree with this analysis, I hope you'll post a correction which would get distributed as widely as your original post did.

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  4. I don't believe broadcast DTC has a lifetime value that cannot be more than compensated for by other means of promotion -- remember, I am not proposing that all forms of DTC be banned.

    Anyway, I think we can reach the same conclusion from both analyses: pharma profits would NOT suffer if broadcast DTC advertising were banned.

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  5. Anonymous3:31 PM

    So, does that mean that you retract the conclusion that cutting DTC actually saves the industry money?

    I'm curious, what other forms of promotion generate a higher marginal ROI than what you've laid out for DTC?

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  6. I'm not obliged to retract anything I did not say. I'm only talking about the 60% of the DTC budget that is earmarked for TV. Which still leaves print and Internet, the latter, I believe, has a much higher marginal ROI than broadcast TV.

    What the industry needs is more TARGETED marketing to get the most bang out of its DTC budget.

    It also needs to wean itself from TV, which often stokes the egos of marketers rather than the bottom line.

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  7. Anonymous4:32 PM

    Sorry to belabor the point, but this is a direct quote from your post:

    "That's a drop of $1.2 billion in profit (20% of $6 billion). The $3 billion in savings would more than make up for that loss."

    That is simply not true, because the calculation is invalid - per my original post.

    I understand your sentiment, and it is an opinion shared by many, but your contention that it is backed up by numbers is what I have a problem with.

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  8. Why don't we just agree to disagree as to whose numbers are valid? It's all just an educated, rough calculation anyway.

    Both calculations prove my main QUALITATIVE point: profits will not suffer if TV DTC were eliminated.

    In your analysis, the profit lost equals exactly the money saved by eliminating DTC. In my analysis, the money saved is greater than the profit lost. Since these are only approximations, I see no real difference and the fact remains, the industry certainly would not face a great loss and probably NO loss in profits if TV DTC advertising were banned and it might -- just maybe -- benefit!

    My goal here is to point out to the drug industry how it may benefit financially and definitely benefit in the public relations arena by eliminating TV DTC ads. That makes me pro-industry rather than anti-DTC.

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  9. Anonymous4:10 PM

    It's possible that DTC ads are not all that effective. Taking into account the negative view of DTC with pharma by the public, likely the industry will move to online advertising at select and relevant websites.

    Also, there are several cases where little if any ad spending was directed at particular drugs, yet they still experienced similiar if not greater growth than those advertised.

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  10. Don't get me started on DTC ROI! I've written about that and the lack of it many times.

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  11. Ok John- you are incorrect on two counts. First, you need to use marginal profit analysis, not average profit. The DTC spending is done at the margin, meaning you need to take the variable cost of selling the last pill- more like a 5% cost plus the advertising.

    So DTC returns $2 per $1 cost for the ad and .10 for the cost of the pill. The 20% profit you use iincludes all the fixed costs.

    Second, DTC spending is not $5 billion. Those numbers are list price. All brand managers will tell you that their real spending is 50-65% of reported numbers. DTC soending is about $3 billion in reality against that $284 billion you quote.

    So the $3 billion generates $6 billion and the profit is about 2. billion. Now you are correct that DTC is not a major driver of sales, but good at the margins of promotional spending. For some brands it can be a driver, like antihistamines, ED, or lifestyle drugs like diet pills. For most big brands it is a nice to do but not a creator of blockbuster sales.

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