Big Pharma's R&D Dilemma

Imagine that you run a company with some of your highest-revenue products making significantly less money than they did in the past. What steps would you take? How about investing more in research and development?

The management teams of the big pharma companies don't have to exercise their imagination. They are living the hypothetical scenario described above. How are they responding to this challenge? Let's take a look.

Data and directions
Pharma companies are taking quite different approaches to investing in R&D, as the chart below shows.

Source: Company 10-K and other financial reports.

The split among these big 12 pharma companies is right down the middle. Half increased R&D expenditures in the second quarter of this year compared to last year while half cut R&D expenses.

How did revenue growth or loss impact companies' decisions related to R&D spending? The chart below shows that a direct correlation existed between revenue growth/loss in the most recent quarter and R&D spending increase/decrease for several companies. (Note: Roche data reflects the percent revenue change for the first half of the year rather than the most recent quarter.)

Sources: Yahoo! Finance, company 10-K reports and other financial reports.

Roche was the primary outlier on the positive end of the spectrum, increasing R&D significantly more than its revenue increase. Merck (NYS: MRK) also fit into this category, raising R&D spending by nearly 12% while revenue increased only 1.3%.

On the negative side, Pfizer (NYS: PFE) stands out. The company saw a loss in revenue of 8.7% compared with the same quarter last year. Pfizer cut R&D spending by nearly 24%.

Some companies took different paths, though. The chart below highlights companies that either increased R&D while revenue shrank or decreased R&D with revenue increasing year-on-year.

Sources: Yahoo! Finance, company 10-K reports and other financial reports.

AstraZeneca (NYS: AZN) saw double-digit revenue losses last quarter compared with 2011 yet still increased R&D spending by 15%. Bristol-Myers Squibb (NYS: BMY) also reflects a disparity, with revenue down 18% and R&D spending up by 4.2%. Abbott (NYS: ABT) was the only company to cut R&D spending with increasing revenue. However, net changes for both were small.

Dilemmas and decisions
Some of the big pharma companies face a dilemma requiring tough decisions. They can cut R&D spending to keep the bottom line looking good in the wake of declining revenue. However, cutting R&D too much could jeopardize prospects for launching new moneymaking products.

Another alternative is to continue funding R&D even as revenue drops off. This approach, though, can lead to unhappy investors if earnings suffer too much before the investments pay off.

Pfizer appears to have taken the former approach. Astrazeneca could be a poster child for the latter road, going full steam ahead with R&D spending despite decreasing revenue.

Which is the right path? That remains to be seen.

However, how a company spends its money on R&D is more important than how much it spends. Investors should research the fundamentals and product pipelines of each company before buying the stock. That's the kind of R&D that pays off over the long run.

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Fool contributorKeith Speightsowns no shares in the stocks mentioned above. The Motley Fool owns shares of Johnson & Johnson and Abbott Laboratories.Motley Fool newsletter serviceshave recommended buying shares of and creating a diagonal call position in Johnson & Johnson. The Motley Fool has adisclosure policy.
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