The way Wall Street looks at drug companies has always been a mystery to me. Why are analysts so uninterested in the “Selling, General & Adminstrative” line on firms’ income statements? This is the line that describes how much a company spent on its sales force and its consumer marketing, and the managers who run that stuff.
Mostly, analysts are obsessed with the usual suspects: revenues, net income, free cashflow, and the state of the R&D pipeline. That is as it should be.
But in the majority of companies, SG&A is roughly double what companies spend on R&D. More interestingly, SG&A is a short-term expenditure, with the results of your efforts being reflected in your revenues in the same quarter in which the expenditures occurred. (By contrast, the smaller R&D line only begins to affect revenues about 10 years later, when the drugs finally come on the market.) And drug company execs are constantly talking about improving their marketing return-on-investment.
So I decided to look at three companies — Pfizer, J&J and Novartis — to see if there were any interesting trends in the way that their SG&A expenditures correlate with revenues and gross profit.* Revenues and gross profit are broad measures of how well managers did at promoting and selling the pills they had on hand, and whether they increased or decreased their profitability while doing so.
Guess what? While the three companies’ margins for revenues, gross profit and SG&A look fairly stable quarter-to-quarter, the yield from their SG&A dollars fluctuates much more dramatically. Interestingly, the growth in the yields changes more dramatically still, meaning that companies are creating and destroying value, based on their marketing investments, far more quickly than the income statements would suggest.
The growth of all three companies’ SG&A yields declined last quarter.
Here are graphs for the three companies, showing the growth rates — or lack thereof — for the yield on their SG&A dollars in terms of revenues and gross profit. If you click on them you should get full-size versions. (Continues after the jump.)
Here’s how these graphs were calculated: I used income statements as reported on Google Finance. I then divided the revenues by the SG&A, and gross profit by SG&A, to find the number of dollars yielded in revenue and gross profit by each single dollar spent on marketing. And then I calculated the percentage change, quarter-to-quarter, of those yields.
Interestingly, despite their differing sizes, all three companies like to keep their revenue yield at around $3, and their gross profit yield at about $2, per dollar spent on SG&A. For J&J and Novartis, those yields were very stable. (Novartis is in the middle of an infamous efficiency drive, titled “Project Forward”.) But Pfizer’s yields plummeted through 2007 and only recently have started to recover.
When you look at the growth in yields, you can see it fluctuates wildly. In the first quarter of 2008, all the companies’ marketing dollars added value, and the growth in their yields rocketed. But for some reason — perhaps the result of all those job cuts finally having a deleterious affect on their sales — they couldn’t sustain that growth, and their yields slipped into negative territory.
In other words, their marketing ROI went down.
Of course, this is only three companies and only five quarters, so it’s not very scientific. Nonethless, it demonstrates that whenever you hear a CEO or marketing chief blabbing about doing more with less, becoming more efficient, and getting better ROI, you can test whether they actually did that by seeing if their SG&A yields rose or fell, and whether they grew or destroyed value.
This quarter, Pfizer, Novartis and J&J all destroyed it.
*Why gross profit and not net income? Because net income is affected by a number of things that are outside the control of sales forces and marketing managers, such as R&D, depreciation and interest. Cost-of-goods-sold should remain fairly stable over time.