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Environment

Drug And Oil Profits: How Much Is Enough?

Big profits for ExxonMobil and Pfizer raise issues as many people struggle with costs of gasoline and health

by By Michael Heylin
February 13, 2006 | A version of this story appeared in Volume 84, Issue 7

ExxonMobil has just had a very good year. In 2005, the worldwide oil and gas giant earned $36.1 billion after taxes. This was more than any company has ever earned in a year and 43% higher than the previous record of $25.3 billion that ExxonMobil itself had set one year earlier. Sales in 2005 were $371 billion, the equivalent of more than half the gross domestic product of India.

Pfizer, the world's largest pharmaceutical producer, ran into some problems in 2005, but it still earned $15.0 billion on sales of $51.3 billion for a very handsome profit margin of 29.2 cents on the dollar.

To put the size of these earnings from science-and-technology-based ExxonMobil and Pfizer into some perspective, ExxonMobil's 2005 earnings were nearly three times as large as the combined earnings of the 24 major U.S. chemical companies that C&EN follows. Pfizer's earnings are about 10% higher.

So why are both ExxonMobil and Pfizer somewhat on the defensive these days? ExxonMobil is running advertisements in major newspapers arguing that its earnings aren't really all that high. Pfizer and the drug industry in general have been the topic of downbeat magazine and newspaper articles.

The basic reasons for the defensiveness are fairly clear. It is not nice these days to be perceived in the public arena as making out like a bandit selling gasoline, home heating oil, and natural gas. As prices surge upward, the populace, especially those with low incomes, including many of the elderly, face adverse impacts. Most of the earnings gains for ExxonMobil and other oil companies have resulted from the doubling of crude oil prices over the past two years.

For Pfizer, justifying a near 30% rate of financial return on producing drugs while the system for making them available in the U.S. at reasonable prices is faltering, could prove challenging if the issue becomes sharply focused. So far, it hasn't because of the more diffuse public issue of rising health care costs in general. But it well could.

According to ExxonMobil, the public's misconception about the profits from oil is due largely to the sheer size of oil industry operations. The company's major point, however, concerns profit margin. It claims that in the third quarter of 2005 the oil and gas industry earned 8.2 cents on every dollar of sales. Exxon itself earned 9.9 cents.

According to ExxonMobil, these rates of return were well below 18.5 cents per sales dollar for pharmaceutical and biotechnology companies, 18.0 cents for banks, and 14.1 cents for semiconductor makers for that quarter. Also oil company and ExxonMobil returns weren't that much higher than the average for all industries of 6.8 cents per dollar of sales.

The profit margin for nonpharmaceutical chemical makers that quarter was 6.3 cents per dollar, up from 5.6 cents in the third quarter of 2004.

The Wall Street Journal buys ExxonMobil's argument. In a Feb. 1 editorial that blasts scattered congressional efforts to place some sort of windfall tax on oil producers, it proclaims that "Exxon is guilty only of responding to a market need, and its earnings are nothing to apologize for." It goes on, "The worst thing for the economy right now would be to have American oil companies in no better shape than Ford or GM." Maybe true! But how relevant?

With its earnings where they are, Pfizer cannot make the same profit margin argument. Neither can most of the other major drugmakers. According to C&EN, the combined return for the first three quarters of 2005 for Pfizer and the eight other largest U.S. drugmakers was 21.4 cents on the dollar. This was almost unchanged from 21.6 cents for the year-earlier period. And these companies likely ended 2005 with a rate of return at very close to this level.

So why have we seen in recent weeks stories with such headlines as "As generics pummel its drugs, Pfizer faces uncertain future," "Pfizer's troubles pull down drugmakers," and "After dreary '05, drugmakers see brighter year ahead" in the Wall Street Journal, C&EN, and the New York Times, respectively?

Such stories seem to indicate the acceptance by the press of two apparent and long-held premises of large makers of pharmaceuticals. One is that they are entitled to a return of at least 20 cents per dollar of sales. The other is that any, even a small, decline in the drugmakers' profit margin is a sure sign of an imminent industry collapse brought on by generic drugs and overly heavy-handed government regulations.

This has not been the case in the past. And there is little to indicate it will be in the foreseeable future, even if individual companies have some less than stellar years.

For instance, Pfizer's 2005 earnings of $15.0 billion were down from $16.1 billion in 2004. Its sales of $51.3 billion were down from a year earlier by $1.2 billion. But the company retained its very high profit margin. It claims its 2005 returns reflect operating and financial strength, and performance exceeded expectations driven by new medicines and accelerated cost savings.

Every industry and company can run into problems with the public. Today, for oil and drug producers, it is the combination of large profits and high prices for their products. But then, always-low-prices Wal-Mart, the world's largest retailer with a modest profit margin of about 4 cents on the sales dollar, is also up to its hips in controversy.

The lesson, if any, from all of this? It probably is that companies at odds with the public should not be in denial but should face the issues, analyze them, adjust as appropriate, and communicate.

Views expressed on this page are those of the author and not necessarily those of ACS.

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