An Easier Way to Understand the Pharma Industry

Originally published in January 2015 by Mike Benson, this post was updated with substantive revisions on December 6, 2019.

The pharmaceutical industry is the part of the healthcare sector that deals with medications. The industry comprises different subfields pertaining to the development, production, and marketing of medications. These more or less interdependent subfields consist of drug manufacturers, drug marketers, and biotechnology companies.

The main goal of the pharmaceutical industry is to provide drugs that prevent infections, maintain health, and cure diseases. This industry directly affects the global population, so a number of international regulatory bodies monitor things like drug safety, patents, quality, and pricing. Here are some of those regulatory entities:

• World Health Organization (or WHO)
• US Food and Drug Administration (or FDA)
• Medicines and Healthcare Products Regulatory Agency (or MHRA)

The pharmaceutical industry has made a great deal of progress over the last decade due to a research-oriented approach that has improved technologies, developed infrastructures, and increased research in the field of bioscience. Thanks to biotechnology, various formulations have been developed to cure or stop the growth of several major infections, including HIV and certain types of cancer.

The global pharmaceutical industry was worth an estimated $1 trillion in 2014. In 2013, global pharmaceutical markets generated revenues of $980.1 billion. That year, North America (the US and Canada) contributed 41% of sales, while Europe contributed 27.4%. More recently, in 2018, the global pharma industry stood at $1.2 trillion, and the IQVIA Institute for Human Data Science expects $1.5 trillion by 2023. 

In the drug manufacturing category, the major publicly traded companies include Johnson & Johnson (JNJ), Novartis AG (NVS), Pfizer Inc. (PFE), Merck (MRK), Sanofi, and GlaxoSmithKline (GSK).

Gilead Sciences Inc., Amgen Inc. (AMGN), Celgene Corporation (CELG), Biogen Idec Inc., and Regeneron Pharmaceuticals Inc. are the major publicly traded biotechnology companies.

Pharmaceutical ETFs include the PowerShares Dynamic Pharmaceuticals ETF (PJP), the SPDR S&P Pharmaceuticals ETF (XPH), the iShares US Pharmaceuticals ETF (IHE), the iShares NASDAQ Biotechnology ETF (IBB), and the VanEck Vectors Pharmaceutical ETF (PPH). 

The supply chain of the pharmaceutical industry is similar to that of any other industry in the manufacturing sector. However, in the US, the pharmaceutical industry has only two drug distribution channels: prescription and OTC (over-the-counter). The US Food and Drug Administration regulates both of these channels.

Here is a typical pharma industry supply chain:

Because pharmaceuticals directly affect millions of people’s health, industry manufacturers are very strict about ensuring the safety and quality of drugs at each level of the supply chain. These companies use fixed, regulator-certified suppliers of raw materials. Companies also store the raw and packaging materials in separate warehouses.

After a company processes the raw materials, it makes the final drug at the manufacturing unit. A company that has a single manufacturing unit uses only one warehouse, while a company with multiple manufacturing units stores its drugs in central and regional warehouses.Next, distributors and super stockists receive the drugs and supply them to entities in the retail segment:

• hospitals
• pharmacy stores
• health care centers
• clinics

Then, retailers sell OTC drugs directly to consumers. A prescription drug purchase requires authorization from a qualified doctor. 

Supply chain importance for pharma companies

Pharmaceutical companies with large turnover place a particular emphasis on supply chain management. This is because any variation in the supply chain could lead to multiple disturbances in the system.

GlaxoSmithKline (GSK) spends over $4.5 billion each year manufacturing and supplying products. Johnson & Johnson (JNJ) spends approximately $30 billion annually in leveraging its purchasing power to set sustainability expectations beyond its operations.

Similarly, companies like Teva Pharmaceuticals (TEVA), Pfizer (PFE), and Merck spend millions of dollars to ensure the safety and supply of their products, even though they have manufacturing units in multiple locations.

A number of ETFs focus on the pharmaceutical industry. One of them is the VanEck Vectors Pharmaceutical ETF (PPH). Over 58% of PPH’s investments are in large pharma companies.

There’s a web of regulations in the research-intensive, highly dynamic pharmaceutical sector. In fact, the industry regulates the entire drug life cycle, including the patent application, competition with generics, marketing approval, and patent expiration. Regulations also control all prescribing physicians, wholesalers, retailers, and manufacturers in the pharma industry.

Regulation objectives

Pharma industry regulators seek to monitor various drug-related concerns:

• safety
• quality
• quantity
• market flow
• research and development incentives
• pricing
• patents

According to the FDA (US Food and Drug Administration), American consumers benefit from having access to the safest, most advanced pharmaceutical system in the world. The main consumer watchdog in this system is the FDA’s Center for Drug Evaluation and Research (or CDER), which assesses new drugs before they hit the market. The center ensures that brand-name and generic drugs work correctly and that their health benefits outweigh their known risks.

International regulatory bodies

International regulatory bodies for the pharma industry include the WHO (World Health Organization), the FDA, and the MHRA (Medicines and Healthcare Products Regulatory Agency). It is important for companies in the pharmaceutical industry to follow the policies set by these organizations. Regulatory bodies monitor not only manufacturers, but also drug sellers and prescribing physicians.

The pharmaceutical industry functions just like any other industry. It has raw materials manufacturers, finished goods manufacturers, R&D (research and development) companies, marketing companies, and consumers. Yet, it’s far more regulated and capital-intensive than other industries.

Drug manufacturing

Drugmakers include API (active pharmaceutical ingredients) and formulations manufacturers. These companies make the following types of drugs:

• APIs. These are the raw materials used to manufacture drugs. Generally, large setups make APIs because these capital-intensive materials require special environmental conditions.

• Generic drugs. Companies sell these off-patented, cost-effective drugs at low prices using no specific brand name in order to serve the public. Abbott Laboratories (ABT), Allergan (AGN), and many other pharma companies make generics.

• Patented drugs. Companies develop these drugs through in-house research or licenses from other firms and then manufacture the drugs under licenses from patent holders. Patented drugs have high profit margins. Pfizer Inc., Merck & Co. (MRK), Sanofi, GlaxoSmithKline, Teva Pharmaceutials (TEVA), and many others make patented drugs.

• CRAMS (contract research and manufacturing services). Companies that provide these contract services conduct research and manufacture drugs under licenses from other companies.

Drug marketing

Marketing companies in the pharma industry help increase the market reach of drugs. At times, a manufacturing company can’t sell its product in a specific region because the company lacks a license or marketing network to do so. This is where drug marketing companies come in to facilitate sales.

Biotechnology and R&D

Pharmaceutical companies are either dependent on their in-house R&D centers, or they rely on biotechnology companies to provide them with licenses to manufacture patented products. Holdings of the PowerShares Dynamic Pharmaceuticals ETF (PJP) include drug manufacturers and biotechnology companies.

A number of questions arise when we think about the current state of the pharmaceutical industry:

• Why is there an increasing need for pharmaceuticals?
• Why have medications become so complex?
• What factors have led to the growth of the pharmaceutical industry?

Below, we explore these questions.

Aging population

Worldwide, the average human life span has increased substantially over the last few decades. However, more infections and diseases have come along with this longevity growth. This has led to increased research on aging populations. The goals are to prevent infections and maintain health so that these populations can enjoy better lives.

Changing lifestyles

Hectic daily schedules have led to unhealthy eating habits, a lack of exercise, less sleep, and other problematic lifestyle choices. This has resulted in high obesity rates, poor digestion, hallucinations, breathing difficulties, and other physical problems. Health supplements have been introduced to remedy all of these issues, reduce the chance of getting sick, and meet daily nutritional needs through vitamins and minerals.

Increased income and chronic diseases

The middle class has been growing in both the emerging and developed markets. People in these markets have more disposable income and expect better healthcare solutions.

Chronic disease cases have risen in number. This has made people become more dependent on medications and health supplements.

Other economic trends

Globalization and urbanization have led to increased environmental disturbances. These are major driving forces in the growing demand for improved medication and health supplements for each age group and geographic location.

Industry players

Companies like Abbott Laboratories (ABT), Novartis AG (NVS), GlaxoSmithKline (GSK), and Teva Pharmaceutical Industries (TEVA) are constantly looking at consumer needs and upgrading drugs based on research and innovation. All four of these companies are part of the VanEck Vectors Pharmaceutical ETF (PPH).