United
environmental Protection
Agency
Effluent Gtsidfiinas Division
WH-SS2
Wasmngtor> DC 20460
EPA-440/2-82-C1?
November 1982
Wate
Economic Analysis of
Proposed Effluent Standards
and Limitations for the
Pharmaceutics! Industry
QUANTITY
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:onomic Analysis of Proposed Effluent Standards and
Limitations for the Pharmaceutical Industry
foe
U.S. Environmental Protection Agency
Office of Analysis and Evaluation
Washington, DC 20460
by
Meta Systems Inc
Cambridge, MA
Under Contract No.
63-01-6152
November 1982
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Preface
The attached document is a contractor's study prepared for the Office
of Water Regulations and Standards of the Environmental Protection Agency
("EPA"). The purpose of the study is to analyze the economic impact which
could result from the application of alternative 3PT, BCT, BAT, PSES, SSPS
and PSNS limitations and standards established under the Federal Water
Pollution control Act (the Act), as amended.
The study supplements che technical study ("EPA Development Document")
supporting the proposal of regulations under the Act. The Development
Document surveys existing and potential waste treament control methods and
technology within particular industrial source categories and supports
proposed limitations based upon an analysis of the feasibility of these
limitations in accordance with the requirements of the Act. Presented in
the Development Document are the investment and operating costs associated
with various alternative control and treatment technologies. The attached
document supplements this analysis by estimating the broader economic
effects which might result from the required application of various
control methods and tecnnologies. This study investigates the effect of
alternative approaches in terms of price increases, effects upon
employment and tne continued viaoility of affected plants, and otr.er
competitive effects.
The study has been prepared with the supervision and review of the
Office of Analysis and Evaluation of the SPA. This report was submitted
in fulfillment of Contract No. 63-01-6162, by Meta Systems Inc. This
report reflects work completed as of November 1982.
This report is being released and circulated at approximately the same
time as publication in the Federal Register of a notice of proposed rule
making. It will be considered along with the information contained in the
Development Document and any comments received by EPA on either document
before or during proposed rule making proceedings necessary to esta'olisn
final regulations.
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Table of Contents
Page >io.
Section 1: Executive Summary
Introduction 1-1
Effluent Limitations and Standards 1-1
Industry Profile 1-2
Economic Impact Methodology 1-3
Economic Impact Analysis 1-4
New Source Performance Standards 1-6
Pretreatment Standards for New Sources 1-6
Resource Conservation and Recovery Act 1-6
Regulatory Flexibility Analysis 1-6
Social Costs 1-6
Limits of the Analysis 1-7
Section 2: Effluent Limitations and Standards
Option Descriptions 2-1
Section 3 ;. .Industry Profile
Definition of the Pharmaceutical Industry 3-1
Industry Size and Cost Structure 3-3
Pharmaceutical Companies 3-9
Establisnment Characteristics 3-14
Final Product Groups 3-16
Government Involvement ..... 3-20
Foreign Trade 3-22
Summary 3-23
Section 4: Economic Impact Methodology
Basic Analytic Framework 4-1
Assessment of Economic Impacts 4-1
Sources of Information 4-2
Treatment Costs 4-3
Treatment Costs to Sales Ratio 4-6
Closure Analysis 4-7
Section 5: Economic Impact Analysis^
Introduction 5-i
Best Practicable Control Technology Currently Available (3PT) 5-2
Best Conventional Pollutant Control Technology (3CT) 5-3
Combined Effect of Proposed BPT and 3CT Regulation 5-7
Best Availaole Technology Economically Achievable (BAT) 5-9
Pretreatment Standards for Existing Sources (PSES) 5-9
Resource Conservation and Recovery Act 5-16
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Table of Contents
(continued)
Page No.
Section 6: New Source Performance Standards (NSPS) and Pee treatment
Standards for Hew Sources
NSPS ........................... . ..... 6
5-3
Section 7; Regulatory Flexibility Analysis
Definition of a Small Firm ...................... 7-1
BPT Regulation ............................ 1-2
3CT Regulation ............................ 7-2
BAT Regulation ....... ..................... 7-3
PSES Regulation. .... .................. ..... 7-3
BPT, BCT, and PSES Combined ............... . . ..... 7-5
Section 3: Social Costs of Proposed Regulations ........ ... S-i
Section 9: Limits of the Analysis
Definition of the Industry and Sample Size ......... . ..... 9-1
Treatment Cost to Plant Sales Metncd ....... . ......... 9-2
Individual Plant Assessments ..................... 9-2
Appendix A: Estimation of Pharmaceutical Plant Sales ......... A-l
Appendix S: Detailed Descriptions of Product Group, .......... B-l
Appendix C; Capital Recovery Factor ................. C-l
11
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List of Tables and Figures
Page No.
Table 3-1: Summary of Selected Measures of Size for the
Pharmaceutical Industry 3-4
Figure 3-1: Breakdown of the 1976 Pharmaceutical Sales Dollar .... 3-5
Tacle 3-2: Absolute and Relative Distribution of tne U.S.
R&D Dollar for Etnical Pharmaceuticals in 1977 3-7
Table 3-3: Capital Expenditures and Labor Cost for
Pharmaceutical Establishments by SIC Groups
in 1977 3-3
Table 3-4: Company Employment and Sales Distributions for
the "308" Survey Companies 3-1C
Table 3-5: Concentration Ratios for Firms Operating
Pharmaceutical Establishments, by SIC
Classification 3-11
Taole 3-6: A Measure of Company Integration in the
308 Sample 3-12
Taole 3-7: Number of Pharmaceutical Establishments
Reported by Private Versus Public Companies 3-13
Table 3-3: Extent of Foreign Ownership
in Domestic Pharmaceutical Companies 3-14
Table 3-9: Establishment Sales and Employment
Distributions 3-14
Table 3-10: Average Establishment Sales and
Employment Data 3-15
Table 3-11: Specialization Ratios of Pharmaceutical
Establishments by SIC Classification 3-16
Taole 3-12: Pharmaceutical Final Product Class Value
of Shipments 3-13
Table 3-13: Breakdown of Final Product Classes Into Ethical and
Proprietary Drug Categories (1977) 3-19
in
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List of Tables and Figures
(continued)
Page No.
Table 3-14: Value of Pharmaceutical Exports ....... . 3-24
Table 3-15: Value of Pharmaceutical Imports 3-24
Tabla 3-16: World Distribution of Exports in 1980 .......... 3-25
Table 3-17: World Distribution of Imports in 1980 3-25
Table 4-1: Industry Profit Levels 4-6
Table 5-1: Computation of Total Cost of Compliance
for BPT 5-3
Table 5-2: Impact Ratios for Plants With BPT Costs Grearer
Than Zero and/or Plants With SPT and BCT Costs
Summed Exceeding One Percent of Sales .......... 5-4
Table 5-3: Computation of the Total Cost of Compliance
for trie Proposed BCT Regulation 5-5
Table 5-4: Maximum Loss of Employees Due to Proposed
BPT and BCT Regulations 5-8
Table 5-5: Computation of Total Cost of Compliance for
tne PSES Cyanide Regulation. 5-10
Table 5-6: Impact Radios for Indirect Discharging
Pharmaceutical Plants. ..... 5-11
Table 5-1: Computation of tne Total Cost of Compliance for
the PSES Removal of Total Toxic Volatile Organics .... 5-13
Table 5-8: Plant Employment Impacts—PSES Regulation
for Steam Stripping and Cyanide Destruction 5-15
Taole 6-1: Incremental Costs to Meet Sew Source
Performance Standards 6-1
Tabla 7-1: Size Distribution of Pharmaceutical Companies 7-2
Table 7-2: Distribution of Firms With Treatment Costs,
by Proposed Regulations, for Firms
Divided by Employment Size 7-4
IV
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List of Tables and Figures
(continued)
Page No.
Table 9-1: 3CT Cost-to-Sales Method: Sensitivity
Analysis 9-3
Table A-l: Summary Statistics of Regression
Database Plant Characteristics A-2
i
Taole A~2 : Plants Removed from Regression Database A-4
Table A-3: Regression Results A-5
Table 3-1: Pharmaceutical Final Product Class Value
of Shipments o-2
Table C-l: Alternative Derivations of the Capital
Recovery Factor C-l
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Section 1
Executive Summary
1. Introduction
As requited by the Clean Water Act, this study presents the economic
effects of the proposed limitations and standards on the pharmaceutical
industry. This study was prepared under the supervision of the Office of
Analysis and Evaluation, U.S. Environmental Protection Agency, This
Executive Summary presents brief descriptions of tne other sections of cne
report. These include:
o Effluent Limitations and Standards
o Industry Profile
o Economic Impact Methodology
o Economic Impact Results
o New Source Performance Standards
o Regulatory Flexibility Analysis
o Social Costs
o Limits to the Analysis
The study is based on data from various sources. The Technical
Contractor provided estimated treatment costs for each plant under eacn
regulatory option analyzed. Employment for each plant was taken from the
308 Survey. Sales for most plants were provided by Economic Information
Systems, Inc. (EIS). For a few of the single-establishment firms, plant
sales were provided by Dun and Bradstreet. For the remaining plants,
sales were estimated on the basis of employment. Information on products
came from a variety of sources, including the 308 Survey, the 1979
Directory of Chemical Producers, state manufacturing guides and studies by
other contractors. Company-level financial data were drawn from annual
reports and/or 10-K reports. Company product information came from a
variety of trade and professional publications, and market studies.
Industry-wide information came from academic studies, trade publications,
market studies, and the U.S. Census of Manufactures: SIC groups 2331,
2833 and 2834,*
2• Effluent Limitations and Standards
This report analyzes the following proposed regulations:
o BPT control of cyanide and revision of the TSS limitations
for direct discharging plants;
o 3CT control of BODj and TSS for directing discharging
plants;
o BAT control of cyanide and COD for direct discharging plants;
* See Section 4, Methodology, for a more complete discussion of
data sources.
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o PSES control of cyanide for indirect discharging plants;*
o NSPS control of 3005, TSS, COD and cyanide for newly
constructed direct discharging plants; and
o PSNS control of cyanide for newly constructed indirect
discharging plants.
3. Industry Pro-file
The U.S. pharmaceutical industry nas been defined by EPA as all
establishments producing: biological products classified in Standard
Industrial Classification (SIC) 2831; medicinals and botanicals classified
in SIC 2833; pharmaceutical preparations classified in SIC 2334; other
pharmaceutically active products not covered by SICs 2331, 2833, and 2334;
cosmetic preparations in SIC 2344 which function primarily as a skin
treatment; and products with multiple end uses at least one of which is as
a component of a pharmaceutical preparation. Establishments engaged
solely in pharmaceutical research ara not included.
U.S. Census of Manufactures data indicate the total value of shipments
in 1977 for pharmaceutical establishments classified in SICs 2331, 2833,
and 2334 were $14.2 billion with value added equal no 39.9 billion. Value
added was one-half of one percent of the $1.9 trillion GNP in that year.
Establisnments in those SICs employed 80.3 thousand production workers and
156.5 thousand overall.
The industry definition covers the production of both bulk
Pharmaceuticals (active ingredients) and final pharmaceutical products.
The final products of the pharmaceutical industry can oe divided into
eleven major raarnet areas. Between 1972 and 1977, tne average uniform
annual growth rate of all eleven groups was 9.3 percent. The group which
experienced the most vigorous growth was the vitamins, nutrients, and
hematinics category at 17.3 percent annually with shipments of SI.3
billion in 1977. Preparations affecting parasitic and infectious diseases
showed the slowest annual growth at 6.3 percent with shipments of $1,3
billion. The 1977 value of shipments of each of the eleven final product
groups ranged from $126 million for active and passive immunization agents
and therapeutic counterparts to $2.2 billion for preparations affecting
the central nervous system and sense organs.
* A second PSES regulatory option was analyzed, which controlled total
toxic organic chemicals as well as cyanide.
1-2
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The industry cost structure is characterized by large expenditures on
R&D and marketing. Approximately 12 percent and 35 percent of sales
revenues are directed towards R&D and marketing respectively. 3efore-tax
profits average about 20 percent of pharmaceutical sales; and after-tax
profits as a percent of sales are between two and three times greater than
the average for other industries.
Pharmaceutical products have two characteristics which effect the
price elasticities, level of competition, and market structure. First,
for the large number of pharmaceutical products which are patented,
competition is greatly reduced and cost increases can be passed on
relatively easily in the form of price increases. Second, ethical drugs
make up a large percentage of total sales. Since ethical drugs require a
prescription, the medical profession influences both total demand and
product choice.
The Food and Drug Administration (FDA) has established an approval
process in order to insure the safety and effectiveness of drugs entering
the market. Additional government involvement is found in the form of:
tax incentives, patent and trademark systems, and generic substitution
laws.
Foreign involvement in the U.S. pharmaceutical industry and U.S.
involvement in world pharmaceutical markets are significant. In 1977, tr.e
U.S. was the largest consumer and the second largest net exporter of
Pharmaceuticals. Foreign involvement in our domestic industry takes the
form of imports, partial ownership of U.S. firms, and domestic
manufacturing facilities owned by foreign firms.
4. Economic Impact Methodology
Using a demand/supply analysis for each product sector, the economic
impacts of the proposed water pollution regulations can be measured in
terms of changes in price and production levels. Two barriers preclude
such an analysis for the pharmaceutical industry: lack of detailed data
and the absence of certain basic market characteristics required for the
demand/supply analysis (for example, a competitive market). As an alter-
native, the methodology assesses the likelihood of establishment closure
due to compliance costs. First, all plants are screened to select those
plants which are likely to have significant impacts. Those establishments
identified by screening are examined in greater detail.
EFA surveyed the industry in the form of a technical 308 Survey.
Responses to this survey included 464 manufacturing facilities, of which
60* were direct discharges and 279* were indirect dischargers, with the
remaining plants zero dischargers (including such methods as deep-well
*Including seven (7) plants which are both indirect and direct
dischargers.
1-3
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injection). The Technical Contractor provided estimates of annualized
treatment costs for each plant under each proposed regulatory option. See
their report for a detailed description of the development of these costs
estimates. The economic impact analysis is based on this sample of 464
plants and their estimated costs.
The screening measure compares estimated annualized incremental
treatment cost of the proposed regulation to establishment sales. If an
establishment incurs costs greater than one percent of sales, further
investigation was considered necessary. Because of the high ratio of
profits to sales in the industry lover 11 percent), treatment costs less
than one percent of sales seemed manageable. Sales data for 202 out of 464
plants were not available. These were estimated based on their reported
manufacturing employment after regressing sales against manufacturing
employment for similar establishments with data.
After screening, each estaolisnment identified oy the cost-to-sales
ratio was examined further. Financial positions and lines of business of
the parent company along with information on products produced, market
positions, and other similar pieces of data on the establishment itself,
contributed to a final expectation of the establishment's ability to
absoro and/or pass tnrough treatment costs.
5. Economic Impact Analysis
Best Practicable Control Technology Currently Available .(3?1).
An estimated six (6) out of the 60 direct dischargers in the 303
sample of 464 establishments may incur costs under the proposed
limitations. The total cost of compliance (in first quarter 1382
dollars*) is:
Total capital cost S2,005,000
Total annualized cost $ 723,000
Jfo plant closures or significant impacts are expected from this BPT limitation.
Best Conventional Pollutant Control Technology (3CT)
Treatment costs may be incurred by approximately fourteen of the 60
direct dischargers as a result of the proposed BCT regulation for 3005
*Section Five uses 1979 dollars. For comparison purposes, costs are
escalated to first quarter 1982 dollars in the Executive Summary, by multiply-
ing 1979 costs by 1.127 to reach 1980 dollars and then by 1.152 to reach first
quarter 1982 dollars. The former figure was provided by the Technical
Contractor while the latter is based on the SNR Construction Cost Index.
1-4
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and TSS. The total cost of compliance for these plants (in first quarter
1982 dollars) is:
Total capital cost $21,337,000
Total annualized cost $ 9,517,000
There are twelve plants with cost-to-sales ratios greater than one percent,
plus a twelfth plant with a ratio exceeding one percent when SPT costs are
included. Of these, one small plant might close. The pharmaceutical line
at another plant might close while the rest of the plant continues operation.
In a third facility the pharmaceutical line might also close or shift to
another plant owned by the same firm.
The combined 3PT and 3CT impacts are nearly the same as those reported
for BCT, with no additional closures. If all three facilities/lines snut
down, the gross employment loss would be, at most, 143 employees. This is
less than one percent of all direct dischargers' employees and less than
0.2 percent of all pharmaceutical manufacturing employees. In general,
the price effects would be small, as would any balance of trade impacts.
Best Available Technology Sconomically Achievable (SAT)
No economic impacts are expected from the proposed BAT limitations
because the technology basis for BAT is the same as that for tne combined
3PT/BCT technologies.
?retreatment Standards foe Existing Sources (PSES)
Two opcions were considered for PSES: one to control cyanide and one
to control both cyanide and volatile organics. The proposed standard
requiring cyanide control may affect three plants out of 279 indirect
dischargers. The total cost of compliance for cyanide control (in first
quarter 1982 dollars) is:
Total capital cost $1,014,000
Total annualized cost $ 379,000
There are no expected closures due to the cyanide standard.
The second option was also analyzed but is not being proposed at this
time. The second option might affect approximately 47 plants. The total
cost of compliance (in first quarter 1982 dollars) is:
Total capital cost $4,517,000
Total annualized cost $5,828,000
Six plants have cost-to-sales ratios greater than one percent; however,
no plants are expectsd to close as a result of this second option. There is
1-5
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a small probability that the pharmaceutical production line at. one facility
may close while the rest of the plant remains open.
If the threatened production lines do close, up to 44 employees could be
affected. This represents about 0.05 percent of the total employment of
indirect discharging plants, and about 0.04 percent of all pharamceutical
manufacturing employment. In general, price increases and balance of trade
impacts are expected to be very small.
New Source Performance Standards jMSgS)
The effluent limitations under NSPS are more stringent than those for
existing sources and consequently coses are somewhat higher. However,
incremental capital costs associated with NSPS are projected to increase the
cost of constructing a new plant by less than two percent. Therefore, -his
increment is not expected to act as a deterrent either to entry or co making a
major modification to an existing plant.
Pretreatment Standards for New Sources (PSNS)
Since the ?SNS limitations on cyanide are the same as those for existing
sources, there are no incremental costs.
Resource Conservation and Recovery kct (RCSA)
RCRA costs were not analyzed because the sludge generated under the
existing 3PT limitations, as well as that to be generated as a result of
the proposed regulations, is not hazardous and therefore not subject to
RC3A regulations.
Regulatory Flexibility Analysis
The differential impact on small businesses was analyzed for each of the
regulatory options separately and for the proposed regulations combined.
The proposed 3PT and PSES regulations have no impacts on small businesses.
The proposed BCT regulation has a potential impact on one small business.
The combined regulations also have a potential impact on one small
business.
Social Costs
Lacking the data necessary to perform a complete social cost
calculation, annual social costs are approximated on the basis of the
capital and annual O&M costs of compliance. The annual social cost (in
1-6
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first quarter 1382 dollars) for the proposed regulations are:
3PT: $ 480,000
BCT: $6,303,000
BAT: Zero Cost
PSES: Cyanide Control $ 260,000
Limits of the Analysis
The limits of the analysis fall into two broad categories: quality of
the data, both technical and economic, and methodological shortcomings and
assumptions.
1-7
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Section 2
Effluent Limitations and Standards
The 1972 Federal Water Pollution Control Act (FWPCA) Amendments (Public
Law 92-500) were primarily directed at the control of industrial and muni-
cipal wastewater discharges. The legislation and subsequent amendments
(Clean Water Act of 1977, Public Law 95-217) require that EPA revise and
promulgate effluent limitations and standards for all point sources of
pollution. Under FWPCA amendments, EPA must develop technology-based ef-
fluent limitations for conventional pollutants (Section 301). Under
another part of the legislation (Section 307), SPA must develop effluent
standards for individual toxic chemicals and ptetreatment standards for
indirect industrial discharges to publicly owned treatment works. These
permissible levels of pollutant discharge correspond to best practicable
control technology currently available (BPT) and best availaois technology
economically achievable (BAT).
The law set specific timetables for achievement of discharge levels
corresponding to these levels of treatment: (July 1977 for BPT and July 1983
for BAT). These timetables were subsequently revised via the 1977 amend-
ments and distinctions were made among pollutants. The original 3PT and
BAT regulations were modified by a new regulatory concept, Best Conven-
tional Pollutant Control Technology (BCT), and the universe of pollutants
was subdivided into conventional, nonconventional, and toxics.
The law has also provided for toxic effluent standards for new sources
and/or discharges to municipal wastewater treatment facilities. These
discharge categories are addressed ay NSPS (New Source Performance
Standards) , PSES (Pretreatment Standards for Existing Sources) and PSNS
(Pretreatment Standards for New Sources).
On November 17, 1976, the EPA promulgated the interim Final 3PT regula-
tions for the Pharmaceutical Industry (40 CFR 439). Under this regulation,
each direct discharger of pharmaceutical manufacturing effluent was required
to achieve: 90% removal of 3005 (long-term average); 74% removal of COD
(long-term average); and a monthly maximum TSS of 52 mg/1. The technical
basis of this regulation has been provided in EPA 440/1-75/060, published in
December, 1976 and known as the 1976 Development Document for the
Pharmaceutical Industry.
Option Descriptions*
Best Practicable Control Technology Currently Available (BPT) Effluent
Limitations—Revised
EPA is proposing to revise the existing TSS monthly average limits with
TSS limits consistent with the 90 percent reduction in 8005 loadings and 74
*Estimates of treatment costs were provided by the Technical Con-
tractor. A complete description of the development of these cost estimates
is provided in the Development Document.
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percent reduction in COD loadings. The revised monthly average TSS limit is
217 mg/1. EPA is also proposing a limitation on cyanide discharge.
The proposed maximum 30 day average is 371 micrograms per liter (ug/1).
EPA is also proposing alternative concentration-based limitations for
30D5 and COD which are equal to the 30-day average maximum 3CT and 3AT
limitations. This is the result of the fact that in some instances, plants
with raw waste loads may be required -co achieve lower levels of BODj and
COD than required by BCT and BAT if the existing percent reduction limita-
tions are applicable. In any case/ the least stringent of the two alterna-
tive limitations [percent reduction or concentration-based)) will apply.
There are no costs associated with these alternative limitations since, if
applied, they would be less stringent than the existing percent reduction-
based limitation.
Best Conventional Pollutant Control Technology (3CT) Sfflueni
Limitations
The proposed BCT regulation sets BOD^ and TSS effluent concentration
limitations for all direct dischargers at:
o 30D5 - 113 mg/1 monthly average
o TSS - 104 mg/1 monthly average
Best Available Technology Economically Achievable (BAT) Effluent
Limitations
BAT proposes a monthly average limit of 570 mg/1 for COD and 375
micrograms per liter (ug/1) for cyanide. EPA believes the technology con-
trols that are the basis for the combined 3PT/3CT limitations can also
serve as the basis for the BAT limitations. Therefore, no incremental
costs or impacts are expected.
Pretreatment Standards for Existing Sources (?SES)
Two options are considered: one controlling cyanide and a second
controlling both cyanide and total toxic volatile organic compounds. The
cyanide limitation is a monthly average of 375 micrograms per liter (for
both options). Treatment system costs were estimated for oxidative
destruction of cyanide with hypochlorite and for treatment of volative
organics using steam stripping. The proposed option is the first option
controlling cyanide only.
New Source Performance Standards (KSBS)
The change in effluent limitations over existing sources include the
following:
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BODj - 31 mg/1 monthly average
TSS - 72 rag/1 monthly average
COD - 449 mg/1 monthly average
Pretraatment Standards for New Sources (PSNS)
This regulation is identical to the limitations proposed for PSES,
2-3
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Section 3
Industry Profile
The pharmaceutical industry can be distinguished from most other 0.5.
industries by its intensive research and development efforts, aggressive
marketing, higher than average profit margins, and multinational character.
A high degree of involvement with regulatory agencies, notably the Food
and Drug Administration (FDA), also contributes to its uniqueness. This
section discusses these and other aspects of the pharmaceutical industry
in order to provide the background necessary for an economic analysis of
the effects of the proposed regulations on the industry. The major sec-
tions included are: I. Definition of the Industry; II. Industry Size and
Cost Structure; III. Pharmaceutical Companies, including lines of ousi-
ness, sales volume, employment, and degree of integration; IV. Establish-
ment Characteristics; V. Final Product Groups, including product sales and
growth rates; VI. Government Involvement; and VII. Foreign Trade. A con-
clusion section, VIII, summarizes important features and trends in the
industry.
I. Definition of the Pharmaceutical Industry
The EPA defined the "Pharmaceutical Manufacturing Point Source
Category" as those manufacturing establishments having any involvement in
the following seven activities:
(1) Production of biological products covered by Standard Industrial
Classification (SIC) Code 2831. This primarily includes olood
and blood derivatives, vaccines, antitoxins, diagnostics, and
other biologicals for human or veterinary use.
(2) Production of medicinals and botanicals covered by SIC Code
2833. Products classified here are synthetic organic and in-
organic medicinal chemicals, as well as botanicals produced and
shipped in bulk.
(3) Production of pharmaceutical preparations covered by SIC Code
2834. Most of these preparations are ready for consumption in
the form of ampuls, tablets, capsules, vials, ointments, medi-
cinal powders, solutions, and suspensions. They include chose
for human or veterinary use.
(4) Production of products by fermentation, biological and natural
extraction, chemical synthesis, and/or formulation which are
considered as pharmaceutically active ingredients by the Food
and Drug Administration, but which are not covered by SIC codes
2831, 2833, and 2834.
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(5) Production of cosmetic preparations included in SIC Code 2844
which function primarily as skin treatments.
(6) Production of products with multiple end uses at least one of
which is as a component of a pharmaceutical preparation (SIC
2834). Examples include binders, fillers, and capsules.
(7) Pharmaceutical research which includes biological, micro-
biological, and chemical research, product development,
clinical and pilot plant activities.
Establishments conducting only pharmaceutical research are not covered by
the proposed regulations and therefore are not included in the analysis.
There are two large data bases containing information related to this
industry. The Bureau of the Census, U.S. Census of Manufactures, defines
the pharmaceutical industry in terms of three SIC groups. These are pro-
ducers of biologicals (SIC 2831), medicinals and botanicals (SIC 2333),
and pharmaceuticial preparations (SIC 2834). These data cover 1,243
establishments.
Industry data are also available from EPA's, Technical Study, acquired
by an industry survey program (referred to as -he 308 Survey)." The need
for rapid response required EPA to request information from plants oelong-
ing to Pharmaceutical Manufacturers Association (PMA) member firms and
non-member firms included in previous EPA guidelines woc'<. This data base
included 244 pharmaceutical manufacturing plants witn other sites oeing
eliminated because they did not manufacture Pharmaceuticals as defined
above, were research oriented facilities, or did not respond. Subsequently,
EPA produced a revised list containing 540 plant sites of approximately 400
companies and distributed a supplemental 308 portfolio to these additional
sites. From these, 220 plants were identified as pharmaceutical manufact-
urers and added to the original data base.** This data base was also used
in the economic impact analysis.
* A detailed description of these data gathering efforts can be found
in Section II of the Development Document.
** Summary of two 308 Surveys:
I I Percent of ', Percent of
i Number ! Total Sent I Total Returned
Questionnaires Sent
Questionnaires Returned
Non-pharmaceutical/
Non-manufacturing
Duplicates
R&D Only
Manufacturing
982
786
233
54
35
464
80%
30%
7%
4%
59%
3-2
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Both the Census and the 308 Survey have shortcomings as data bases for
analyzing these proposed regulations. The Census does not provide
separate data on facilities covered by the regulations but not included in
the three SIC groups considered. In addition, the Census may overestimate
the number of production facilities by including separate product lines as
separate facilities, while the 308 Survey treats them as a single
facility. The 308 Survey does not include all manufacturing sites, but
does include the major ones, including some not assigned to the three
major SIC groups, and the Survey covers most of the pharmaceutical
production. The Census is used as the basis for most of the discussion of
this chapter. Since the Census does not include much of the information
on the companies owning pharma- ceutical plants desirable for the
description of the industry, the company descriptions are based on the 308
Survey.
II- Industry Size and Cost Structure
In the following subsection discussions of industry size and cost
structure are presented based on data provided by the U.S. Bureau of the
Census.
Size
Tabla 3-1 presents data available from the 1977 U.S. Census of Manufactures
for the industry. It breaks domestic pharmaceutical establishments into cate-
gories according to their primary product classifications (not necessarily
Pharmaceuticals) and then presents various measures o£ size—number of estab-
lishments, number of employees, value added, and value of product shipments.
Numoer of Establishments. The table shows that 310 Pharmaceuticals
establishments produce biologicals, 177 produce medicinals and botanicals, and
756 produce pharmaceutical preparations as their primary product. These 1,243
establishments produce 96 percent of the three types of products. The numoer
of facilities producing the remaining four percent is unknown.
Number of Employees. As shown in Table 3-1, these 1,243 pharmaceutical
establishments employed 156.5 thousand persons, with a little more than half,
or 80.3 thousand, directly involved in production. The majority of these were
employed ir. establishments classified in pharmaceutical preparations (SIC Code
2834). However, because some of the production at these establishments is not
pharmaceutically related and no estimate has been made of pharmaceutical
employment at establishments in non-pharmaceutical SICs, these employment
figures may overestimate pharmaceutical employment.
Value Added and Value of Shipments. Value added and value o.f shipments
are measures of the size of an industry. Value added is derived
3-3
-------
Table 3-1
Summary of Selected Measures of Size for the Pharmaceutical Industry
Pharmaceutical Estaolishments Classified
Nuab«; of establishoent*
All esployees (1000 '»)
Production employees UOOO's)
Value added (mmS)
SIC 2831
Biological
Products
310
15.7
3.3
I 563
SIC 2833
Hedicinals/
1 Botanicals
177
14.4
3.4
1 1,162
SIC 2834
Pharmaceutical
I Preparations 1
756
126.4
63.1
, 8,214 |
in<
All
Other
SICs
na
na
na
na
Total 'or All
pharaiaceuticai
1 Establishments
na
na
na
1 na
Value of Product
Shipments for (asS):
I) 3iOloqics.lt
(SIC 2831) 781 244
2) Medicinals and
botanicals
(SIC 2833) 10 1,50(3
3) Pharaaceut leal
Preparations
(SIC 2834) 20 64
4-7) Other products
and activities
in tne Industry
&e£ip.ition^ na na
Production and
miscellaneous
receipts not
in tne Industry
Definition na na
All products 898 { 1,890
1 ^ 1,068
334 312 2,206
9,363 193 9,640
na na na
na na na
1 11,460 ! na na
See the Industry Ce£inition-
Withheld by th« Census o£ Manufactures to avoid disclosure o£ individual operations.
na * not available
Source: Census of Manufacture* (1977)
3-4
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by subtracting the cost of inputs including contract work from the value
of shipments (products manufactured plus receipts for services rendered).
In 1977, value added for establishments in the three SICs totaled $9.9
billion with the majority (S3.2 billion) in pharmaceutical preparations
(See Table 3-1). Value of shipments corresponded, with SO.9, $1.9, and
$11.5 billion for establishments in SICs 2831, 2833, and 2834, respect-
ively. Compared to the 1977 gross national product of 31.9 trillion, the
pharmaceutical industry contributed at least one half of one percent to
national output.
Cost Structure
Breakdown of the Pharmaceutical Sales Dollar. Revenues from
pharmaceutical product sales are used to cover six categories of expendi-
tures: research and development (R&D), capital expenditures and produc-
tion labor, materials cost, marketing, general and administrative expenses
(G&A), and before tax net income (see Figure 3-1).
Figure 3-1
Breakdown of the 1976 Pharmaceutical Sales Dollar
G&A 3%
Net Income
Before Tax
20%
* According to Meta Systems' calculations, based on U.S. Bureau of the
Census data, Material Costs comprise one-third and Capital Expenditues and
Production Labor are two-thirds of the cost of goods sold.
Source: Delphi Marketing Services, Inc.
3-5
-------
Perhaps, the most striking feature of the breakdown is the large
percentage (20 percent) which goes to net income before taxes. The U.S.
Federal Trade Commission reports* that in 1980 pharmaceutical profits were
1.9 times those in the Chemical and Allied Trades Industries (of which the
Pharmaceutical industry is a part) and 2.75 times U.S. industry profits as
a whole.
Excluding before tax net income, the three largest remaining
components are marketing (35 percent), capital expenditures and production
labor (20 percent), and R&D (12 percent). Of the remaining sales revenue,
the cost of purchasing materials consumed ten percent of the
pharmaceutical sales dollar. This includes the purchase of energy and
chemicals, plant and animal matter, oinders, fillers, and other raw
materials required for manufacturing. The last and smallest category,
G&A, claims the remaining three percent.
Research and Development R&D is more important to the pharmaceutical
industry than it is to most industries. Its role in improving existing
products and creating new ones has enabled pharmaceutical companies to
continue to earn above average profits. This seems to be especially true
for competitors in etnical** drug markets.
R&D expenditures fall into two categories: 1) research for the
advancement of scientific knowledge and development of new products and
related services; and 2) research oriented to improvement and/or modifica-
tion of existing products. In 1977, members of the Pharmaceutical
Manufactures Association (PMA) spent SO percent of worldwide R&D on new
products, and 20 percent on improvements in existing products.*** In 1979
(the latest available), PMA member firms spent $1,330 million on domestic
R&D for ethical drugs, with an additional $300 million of company financed
R&D performed outside of the United States. For these PMA member firms,
this represented 3.3 percent of their 1979 worldwide human and veterinary
ethical drug sales.
These R&D expenditures are spread unevenly among product classes,
ranging from 0.4 percent for veterinary biologicals to 16.3 percent for
pharmaceutical preparations acting on the central nervous system and sense
organs. (See Table 3.2.****) The ratio of ethical R&D expenditure to the
* Quarterly Financial Report for Manufacturing Mining and Trade
Corporations, 1980 q4, U.S. Federal Trade Commission.
** Ethical drugs are those wnich require prescriptions.
*** According to the 1980 edition of The Kline Guide to the Chemical
Industry, PMA member firms account for 95 percent of all domestic sales of
prescription drugs.
**** Data for 1977 is the latest year for U.S Census of Manufactures
data on which the product breakdown is based. Since the U.S Census of
Manufactures covers shipments of domestic establishments only, the U.S.
R&D figures are presented rather than global. A global comparison is
preferred because R&D benefits and sales cross national boundaries.
3-6
-------
Table 3-2
Absolute and Relative Distribution of the
U.S. R&D Dollar for Ethical Pharmaceuticals in 1977
1
I
1
SIC 1
Code2 i
23311 i
28312 1
23313 !
23314 !
1
23315 i
23316 I
23310 i
28341 1
!
23342 1
23343 1
1
28344 1
1
23345 1
i
28346 i
23347 1
i
i
13343 !
23349 i
28340 i
1
1
1
! E
Product Class !
Biological Products for
human use 1
1
Biological Diagnostics i
(in vivo) for human use '
Biological Products for i
veterinary use 1
Biological Products for 1
industrial jse '
Biological Products tot !
(p.p.h.u.) affecting neo- i
plasms, the endocrine sys-i
ceit and metabolic diseasesi
(p.p.h.u.) acting on tne !
central nervous system 1
and the sense organs i
ip.p.h.u.'; acting on the !
cardiovascular system !
ip.p.h.u.) acting on the 1
resmracorv system i
(p.p.h.u.) acting on the 1
digestive or genito- i
urinary SYS tens '
Ip.p.h.u.) acting on the ',
skin I
Vitamins, nutrient and 1
henatinic preparations 1
for human use '
{p.p.h.u.) affecting para-i
site and infective disease i
pnarmaceutical prepaca- 1
tion for veterinary use 1
Pharmaceutical prepara- i
ciorts not specified by 1
'« i nd i
Millions
of Dollars
Product 1
Value of i RsD as 1
tnical Drug a Percent 1
Product Domestic or Total ',
Shioments 1 SsO i SsD
na
na
na
na
ha
na
na
379. 5
1675.3
745.1
436.3
725.5
229.8
782.9
1092.9
248.2
na
i 1 i
33 1 3.1 i
1 1 1
1 12 1 1.1 1
i 1
! 4 0.4;
1
—1 — i i
i i
— i , —i ;
i
165 13.7
i
1
1 177 ! 16.3 |
1 1
1 i
150 1 15.2 1
1 i
44 4.2
1
65 6.2 i
1
35 3.3 i
! 1
24 2.3 !
1
196 18.6 i
55 1 6.2 1
i --1 i —1 i
1 1
1 1
R&D as a
Percent on
Ethical Drug
Shipments-^
na
na
na
ha
na
na
n a
13.3
10.5
21.5
9.0
9.0
15.2
3.1
17.9
26.2
na
ip.p.n.u.) • pharmaceutical prepartions for human jse.
na » r»t availaols
"RSD for SIC Codes 28316, 23310, and 23340 totals 573 aiilion and rsareser.ts a.9 percent ot
•SIC 2333 is not included secause it includes only bulk jiedicinals and botanicals.
^Value added siay be a nore relevant parameter foe comparison chan value o£ snipmenta.
Source: Census o£ Manufactures; 1977-73 PMA Annual Survey; and tteta Systems calculations.
3-7
-------
value of ethical product shipments is another measure of che relative
emphasis placed on R&D for each product class. These values range from
3.1 percent in vitamins, nutrient and hematinic preparations to 25.2
percent for pharmaceutical preparations for veterinary use, one of the
smaller groups. Several explanations may oe offered for this variation.
A small percentage may indicate a mature product class where continual
innovation is difficult or unlikely to enhance a firm's market position.
Conversely, a larger percentage might be indicative of intense competition
to maintain market shares through innovation or a reasonable potential for
breakthroughs into new markets. Siogenetic research is an example of this
second case.
Capital Expenditures and Production Labor. Available data indicate
that the Pharmaceutical Industry is not capital intensive. In 1977, for
establishments classified in SICs 2831, 2833, and 2834, capital expen-
ditures equaled less than six percent of value added (see Table 3-3). In
contrast, the Chemical and Allied Products industries is much more capital
intensive with capital expenditures of 15 percent of value added. Pro-
duction labor for the three categories account for ten percent of value
added (see Table 3-3) varying from 9.5 percent in pharmaceutical pre-
parations (2834) to 16.1 percent for biologicals (2331) .
Table 3-3
Capital Expenditures and Labor Cost for Pharmaceutical
Establishments by SIC Groups in 1977
Establishments
Classified in:
SIC 2831
SIC 2833
SIC 2334
Total
1 Expenditures I
| (mm$) |
35.6
125.1
424.1
1 584'8 1
Cost
(mm$)
90.5
127.2
799.4
997.1
1 Capital
^ Expenditures
6.3
10.3
5.2
1 5'9
1 Labor
1 Costs
16.1
10.9
9.5
10.0
Source: 1977 U.S Census of Manufactures.
Marketing. Two distinct advertising and marketing approaches are
employed by pharmaceutical companies. The first strategy pertains to
sales* of proprietary drugs—drugs which do not require prescriptions and
are marketed directly to consumers. Television, radio, newspapers,
* Based on a breakdown of pharmaceutical preparations (SIC 2834) value
of shipments, approximately 73 percent are ethical, 25 percent are
proprietary, with the remaining two percent being bulk shipments (1977 U.S
Census of Manufactures).
3-3
-------
magazines, and billboards are the primary means of promoting these pro-
ducts with the general strategy being similar to. that for most consumer
products.
The second strategy pertains to the sales of ethical products. Since
these drugs require prescriptions, the advertising and marketing strategy
for ethical products is aimed towards doctors. Advertisements in profes-
sional journals and magazines are used to achieve visibility of a product
or product line. In addition/ a "detail" sales force visits individual
doctors as frequently as possible to make a personal sales pitch.
Depending on the company and its product line, the detail force can be
substantial in size.
The dichotomy in marketing strategies is beginning to blur. Some
companies have begun to aim ethical drug ads directly at consumers in the
hope that a more aware consumer may influence doctors' prescription
habits.*
III. Pharmaceutical Companies
The U.S. Bureau of the Census provides detailed information on
individual establishment but only limited information on the individual
companies which manufacture Pharmaceuticals. Therefore, the following
discussion of company characteristics focuses on the sample of companies
in the 308 Survey. This data base consists of 464 establishments owned by
243 companies.** Based on a comparison of the 308 Survey data with the
Census data, the 308 data contains a larger proportion of big companies
and big establishments.
While the majority of the companies associated with che pharmaceutical
industry tend to be small, the major portion of pharmaceutical sales are
attributable to a relatively small number of large, diversified firms. In
che following discussions, companies are characterized in terms of sales
and employment, concentration, integration, lines of business and
ownership.
* Newsweek, March 1982.
** The 1977 U.S Census of Manufacturers identifies 249 companies in SIC
2831, 154 in SIC 2833, and 555 in SIC 2334. Mo information is provided
regarding how many companies have establishments in more than one of chese
SIC groups. Therefore, the total number of firms with establishments in
these three SIC groups ranges from 655 to 1058. As discussed earlier,
some establishments (and therefore some firms) in these SIC groups may not
be covered by these proposed regulations. In addition, the 308 Survey
included some establishments covered by the regulation which may not fall
in these three SIC groups.
3-9
-------
Sales and Employment
The distribution of sales and employment among the 243 companies in
the 308 Survey is shown in Table 3-4. As might be expected, these two
parameters are highly correlated. Mean employment was 10,500 and mean
annual sales was $1.0 billion. Data are frequently unavailable for small
privately held companies causing these figures to be overestimates. In
addition, some companies own more than one establishment, and these may be
non-pharmaceutical establishments, and therefore, the sales and employment
figures by company are larger than the same statistics calculated by
establishment.
Table 3-4
Company Employment and Sales Distributions foe the
"308" Survey Companies
Employment
Number of
Employees 1 Companies
0 - 100
100 - 1,000
1,000 - 10,000
10,000 - 100,000
More than 100,000
Hissing employment
data
98
42
37
43
4
19
I
1
! Sales
0
10
100
1,000
Sales
Number of
(MM$) i Companies
- 100
- 100
- 1,000
- 10,000
More than 10,000
Missing
sales data
95
34
33
43
5
33
Total
243
Total
243
Source: 1Q-K and Annual Reports ^Fiscal 1980)
State Industrial Guides.
Dun and Bradstreet,
Concentration
The degree to which sales are concentrated in a few companies is often
measured by the four-firm and eight-firm concentration ratios. A high
ratio indicates that a few firms control a large segment of the market,
and this may result in less competition. As shown in Table 3-5, this
industry is quite concentrated for SIC 2831 and 2833. Pharmaceutical
preparations (SIC 2834) is much less concentrated. The U.S Census of
Manufactures also publishes concentration ratios for each SIC group. In
all cases, the concentration ratios based on the 308 Survey are higher
than those provided by the Census. In part this is due to the Census
3-10
-------
including a higher proportion of smaller firms than does the 303 Survey.
The concentration of firms manufacturing pharmaceutical preparations (SIC
2834) has remained relatively constant since at least 1947 in spite of a
trend in the pharmaceutical industry toward fewer and larger companies.*
Table 3-5
Concentration Ratios for Firms Operating
Pharmaceutical Establishments, by SIC Classification
SIC Group
2831
2833
2834
I Percent of Total
.1 Four Laraest Firms
1 63
1 62
1 28
Sales
i
1
1
1
Attributable
Eight Larges
83
85
48
to
t Firms
Source: 308 Survey and Meta Systems' calculations.
Concentration ratios are based on total sales rather than pharmaceutical
sales alone. However, since the specialization ratios are high in SICs 2831,
2833, and 2834, it is reasonably certain that these concentration ratios apply
to pharmaceutical sales as well. (See discussion of specialization under
"Pharmaceutical Establishments".)
Integration
Before 1950, few pharmaceutical producing companies were integrated from
research and development through to formulation and marketing. With the
maturing of research and development, new markets developed and competition
between similar patented products became more common. Company level
integration increased markedly during the 1960's-.** Today, the industry is
characterized by large integrated pharmaceutical and cosmetics companies,
large chemical companies that are not integrated along pharma- ceutical lines
and smaller, less integrated companies. Virtually all of the large
pharmaceutical firms are integrated from R&D to marketing, and these large
firms dominate RS.D in the industry.
* Peter Temin, "Technology, Regulation, and Market Structure in the
Modern Pharmaceutical Market," Bell Journal of Economics, Autumn 1979,
Vol. 10(2) .
** Peter Temin, op. cit..
3-11
-------
The 308 Survey provides data on the production processes employed by
each firm. Dividing these up into two categories: (1) bulk manufacturing
by chemical synthesis, fermentation, or biological extraction, and 2)
formulation, a partial measure of integration is possible. See Table
3-6. It is only partial because the R&D segment of the industry has been
ignored. By this measure 28,4 percent of the companies are integrated
from manufacturing to formulation, while the majority (59.3 percent) only
formulate.
Table 3-6
A Measure of Company Integration in the 308 Sample
Number of Percent of
Activity Companies* Total
Chemical synthesis, 1 30 I 12.3
fermentation, and/or i I
extraction only ! I
Formula-tion only , 144 . 59.3
Both 69 , 28.4
Total 243 100.0
* Two companies lacked production data.
Source: 308 Survey and Meta Systems' calculations.
Lines of Business
Although most companies involved in pharmaceutical activities are
principally pharmaceutical companies, some non-pharmaceutical companies are
also involved. The latter situation usually occurs when the pharmaceutical
production is a by-product of a major line of business. Examples are:
chemical companies which also produce medicinal chemicals, such as Tenneco,
Inc.'s production of salicylic acid; and a consumer products company, such
as General Poods' production of the medicinal caffeine for use in cold
remedies.
Of the 243 companies in the 308 sample, 212 are classified by Dun and
Bradstreet according to their principal activity. Nearly two-thirds or 141
are principally active in SIC codes 2831, 2333, or 2834. Most of these
companies (123) are associated with SIC 2834. SICs 2831 and 2833 were
assigned to 4 and 14 companies, respectively. Outside of these three SIC
groups, the largest concentration of companies is found in SIC groups 281
(industrial inorganic chemicals), 284 (soap, detergents, perfumes, cosmetics
and other toilet preparations), 286 (industrial organic chemicals) and 384
(surgical, medical and dental instruments and supplies).
3-12
-------
Ownership
Public companies tend to be larger than private ones in most U.S.
industries.* The pharmaceutical industry follows this pattern. Table 3-7
indicates the number of pharmaceutical establishments owned by aach firm
in the 308 data base. The 93 public companies own 279 pharmaceutical
establishments and 152 private firms own only 185 pharmaceutical
establishments.
During the past decade, foreign ownership has become an important
characteristic of pharmaceutical companies manufacturing in the United
States. Table 3-8 shows the ownership status of the 243 companies on the
308 data base, with 24 out of 243 companies having more than ten percent
foreign ownership. One third of these represent foreign purchase of stock
available in the U.S. The remaining two-thirds ace firms which do not
file lOKs and therefore are privately owned, publicly owned with no stock
for sale in the United States, or owned by a foreign government.
Table 3-7
Number of Pharmaceutical Establishments
Reported by Private Versus Public Companies
(Number of Pharmaceutical Establishments Owned
1 I I Three I 1
I | I or I Five or 1
Ownership
Public
Private
Total
One
50
138
188
Two 1 Four
10 . 10
5 5
15 ( 15
I Greater 1 All
23 , 93
2 , 150
25 , 243
* The term "public company" is defined as a company required to file
10K reports with the SEC. This definition may exclude foreign public
companies with U.S. operations from the public category.
3-13
-------
Table 3-8
Extent of Foreign Ownership
in Domestic Pharmaceutical Companies
Percent Foreign
Ownership
I Publicly
1 Held
1 Privately I
1 Held
I All
Greater than
10 percent 8 16 24
Less than or equal
to 10 percent
All
Source: 308 Survey, EIS and 10K Reports.
IV. Establishment Characteristics
The following discussion is based on data from the U.S. Census of
Manufactures. Establishments are characterized in terms of sales and
employment, geographic distribution, specialization, age, and discharge
status.
Sales and Employment
The employment distribution across establishments is presented in
Table 3-9. Over one-half of the establishments have fewer than twenty
employees.
Table 3-9
Establishment Employment Distributions,
for Establisnments in SIC Codes
2831, 2833 and 2834
Number of I Number of I Percent of Total
Employees I Establishments i Establishments
1- 4 449 36
5- 19 312 25
20- 99 262 21
100- 499 151 12
500-2499 59 5
More than 2499 10 1
Total , 1243 , 100
Source: U.S. Census of Manufacturers (1977).
3-14
-------
Average annual sales and employment have been calculated for each of
the three SIC classes (see Table 3-10). SIC 2334 establishments tend to
be larger and SIC 2831 establishments tend to be smaller than the average
pharmaceutical establishment.
Table 3-10
Average Establishment Sales and Employment
Sales (MM$) I Employment
SIC 2831
SIC 2833
SIC 2834
Mean for the
three SIC groups
2.9
10.7
15.2
11.5 ,
51
31
167
126
Source: U.S. Census of Manufactures (1977).
Geographical Distribution
According to the U.S Census of Manfactures, 41 percent of all
pharmaceutical establishments are located in New Yor!^, Illinois, and
California. Since the Census does not report on plants located in Puerto
Rico/ the specific number of plants located in Puerto Rico is unknown.
However, in 1979, there were 76 drug and pharmaceutical establishments in
Puerto Rico.*
Specialization
The specialization ratio is defined here as the ratio of the value of
product shipments for products included in the industry definition (i.e.,
sum of products in SIC 2831, 2833 and 2834) divided by the total value of
product shipments at the establishment (See Table 3-11.).**
* The Drug and Pharmaceutical Industry in Puerto Rico, June 1980,
Puerto Rico Economic Development Administration, p. 2.
** The U.S. Census of Manufactures defines specialization in a slightly
different way. It is the ratio of products in the plant's own SIC group
only divided by the total shipments of that plant. The Census
specialization ratios are slightly less than the ones calculated by Meta,
but also show a highly specialized industry.
3-15
-------
Table 3-11
Specialization Ratios of Pharmaceutical Establishments
by SIC Classification
Establishments
Classified in SIC
Minimum Specialization Ratio
(Percent)
2831
2833
2834
96
86
92
Source: 1977 U.S. Census of Manufactures and Meta Systems'
calculations.
These ratios demonstrate that pharmaceutical establishments are highly
Specialized.
Another measure of specialization provided by the U.S Census of
Manufactures shows that of the 310 establishments in 2831, 294 (94.8
percent) have greater than 75 percent of their production within that SIC
group. Likewise, 90.4 percent and 90.3 percent of the establishments in
SICs 2833 and 2334 have at least 75 percent of their production falling in
their primary SIC.
Age
The establishment age distribution is illustrative of industry capital
improvement trends. The U.S Census of Manufactures does not provide this
information, but data on the start up year was provided for 232 of the 464
establishments in the 303 Survey. According to this data a disproportion-
ately large number of older plants exist in the upper Midwest, while the
newer plants are disproportionately concentrated in Puerto Rico, the loca-
tion of 26 of the 73 establishments which opened between 1970 and 1977.
V. Final Product Groups
For the purposes of the economic analysis, final pharmaceutical
products are grouped into eleven major classes following the U.S. Census
Bureau classification scheme. The nine major groups from SIC code 2834
(Pharmaceutical Preparations) and two groups from SIC 2831 were selected.
SIC code 2833 (medicinals and botanicals) was not included because almost
3-16
-------
all products within it are feedstocks to SIC 2834 finished products. The
eleven major groups are*:
1. Preparations affecting neoplasms/ endocrine system and
metabolic diseases.
2. Preparations affecting the central nervous system and sense
organs.
3. Preparations acting on the cardiovascular system.
4. Preparations acting on the respiratory system.
5. Preparations acting on the digestive and genito-urinary
systems.
6. Preparations acting on the skin.
7. Vitamins, nutrients and hematinic preparations.
8. Preparations affecting parasitic and infective diseases.
9. Preparations for veterinary use.
10. Blood and derivatives for human use.
11. Preparations for active and passive immunization and
therapeutic counterparts.
Since the Second World War, the pharmaceutical industry has grown at a
rate much greater than the average for all industries. Table 3-12 shows
the value of shipments and percent annual change rot: the major product
groups from 1972 to 1977. Value of shipments growth following 1974 had a
much larger inflationary component than growth prior to that year.
Consequently, it is difficult to determine "real" growth from tnis table.
Table 3-13 breaks each product class into its ethical and proprietary
components. Ethical drugs, those promoted primarily to the medical pro-
fessions, comprise approximately 73 percent of the total value of ship-
ments of final products (SIC 2834).** Although most pharmaceutical
companies produce both ethical and proprietary drugs, the distinction is
important for discussing the market characteristics, namely volume growth
and price trends, of each product class. Research and patents tend to be
more important in the ethical drug markets. In addition, profits in these
markets tend to be higher. These factors, combined with marketing
differences (targeting the medical professions versus consumers) make the
ethical/proprietary distinction a relevant one.
* A more complete discussion of each of these groups, including
important subgroups within each major group and their market
characteristics can be found in Appendix B.
** This percentage varies across product classes. Ethical drugs as a
percent of total value of shipments ranges from 37 percent for
preparations acting on the skin to 99 percent for preparations affecting
the cardiovascular system.
3-17
-------
Table 3-12
Pharmaceutical Final Product Class Value of Shipments
(current dollars)
Product Class
1 Value of Shipments ! Uniform Average
I Millions .of Dollars I Increase
I 1977 I 1972 (Percent)
Preparations affecting neoplasms, 900 615 7.9
endocrine system and metabolic
diseases
Preparations affecting central 2231 1636 6.4
nervous system and sense organs
Preparations affecting 751 400 13.4
cardiovascular systam
Preparations affecting 896 561 9.8
respiratory system
Preparations affecting digestive 1074 746 7.6
and genito-urinary systems
Preparations affecting the skin 621 344 12.5
Vitamins, nutrients and hematinics 1302 537 17.3
Preparations affecting parasitic 1285 948 6.3
and infectious diseases
Preparations for veterinary use 354 214 10.6
Blood and blood derivatives 243 126 14.1
for human use
Active and passive immunization 126 89 7.2
agents and therapeutic
counterparts
Total
9783
6266
9.3
Source: 1977 U.S Census of Manufactures Report (Current Industrial
Reports figures).
3.-18
-------
Table 3-13
Breakdown of Final Product Classes Into Ethical and
Proprietary Drug Categories (1977).
Product Class
Preparation affecting
neoplasms, the endocrine
system, and metabolic
diseases
Preparations affecting
the central nervous system
and sense organs
Preparations affecting the
cardiovascular system
Preparations affecting the
respiratory system
Preparations affecting
digestive and genito-
urinary systems
Preparations affecting the
skin
Vitamins, nutrients, and
hematinics
Preparations affecting
parasitic and infectious
diseases
Preparations for veterinary
use
To tal
1
!Et
1 n
Value of Shipments (mmS) 1 E
Ethical! Prop rietary lBulk+1 To tal@ 1
880 ! * 1 20 1 900 1
1675 1 538 ! 17 1 2231 1
745 | * ! 5 1 751 !
477 ! 412 I 7 1 896 1
726 1 336 I 12 1 1074 |
230 1 373 | 13 1 621 !
783 1 382 ! 137 ! 1302 I
1093 1 176 ! 16 I 1285 1
248 1 94 1 11 i 354 1
6857 I 2316 | 239 1 9414 |
Value of
hical Ship-
lents as a
ercent of
Total
97.8
75.1
99.3
53.2
57.5
37.0
60.0
35.1
70.1
72.8
-Preparations shipped in bulk, not considered as ethical or proprietary.
*Not applicable.
3Some totals may not equal the sum of the parts due to rounding.
3-19
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VI. Government Involvement
Regulation to protect the consumer is one of the most important ways
the Federal Government influences the pharmaceutical industry. In
addition, there are federal regulations governing patent and trademark
systems and federal tax incentives which influence industry activities.
Consumer Regulation
The Food and Drug Act of 1906 set up minimum standards of strength,
quality, and purity for drugs marketed in interstate commerce.* The first
major revision was the Food, Drug, and Cosmetic Act of 1938 which emphasized
safety by requiring that any new drug not generally recognized as safe be
shown to be so prior to marketing. Today, drugs also have to be demon-
strated as effective, as required by 1962 amendments to the Food, Drug, and
Cosmetics Act.
The development of a safe and effective drug and the associated
regulatory requirements can be characterized in three basic steps. The
first is the establishment and investigation of a chemical formulation witn
a potential for use as a pharmaceutical. This includes testing of the
compound's chemical and toxicological properties. Second, if the compound
is promising, further tesing is done including the use of animal subjec-s.
If the prognosis is still favorable, an Investigational New Drug (IND)
application is filed with the FDA to obtain permission to test the drug on
humans. If approved, the third step is clinical testing on human
subjects—'first on healthy volunteers, then on those suffering from the
symptoms or disease to be treated by the drug. After completion of the
clinical tests, a New Drug Application (NDA) is filed with the FDA. If
approved, the drug can be marketed.
Due to the long process, the tremendous cost involved, and the
signficant attrition rate of potential new drugs, R&D has increasingly
focused on the potentially lucrative therapeutic markets—problem health
areas such as cancer and heart disease—where a successful drug could create
a sizable market and earn significant profits.
There is growing concern that these regulations are stifling innovation
and thus, reducing the number of important new drugs developed. The
relationship is not a simple one. However, steps are being taken to reduce
the time involved in the FDA approval process
* In effect this includes all drugs. The interstate commerce clause of
the Constitution is often cited as the authority for Federal regulation.
3-20
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Another area of federal consumer regulations involves generic drugs.
The Court of Appeals for the 3th Circuit recently upheld the PDA's con-
tention that a generic copy of an approved drug with the same active
ingredients must be submitted for approval since the inactive ingredients
may alter the safety and/or effectiveness of the product.* The generic
drug companies do not want to incur the time and expense of this approval
process.
Patents and Trademarks
Under the current Patent Act, a patent provides its holder with 17
years of exclusive rights to an innovation. Patents may cover new
compositions of matter, as well as new processes or new uses for an old
substance (the latter possibility was added with the 1952 Amendment).
Opinion concerning the merits of patents in the pharmaceutical industry
vary significantly. On the positive side is the incentive for innovation
supplied by the patent. Seventeen years of exclusive rights to a drug
formulation can be quite profitable and is often necessary to pay off the
resource intensive investment in the development and approval of a new
drug, with society benefitting from the proliferation of new products.
On the negative side, patents are sometimes viewed as a barrier to entry.
New companies are allowed to produce, subject to FDA approval, any of the
many drugs not covered by patents? however, these tend co be less profit-
able. The other major drawback is the tendancy of drug companies to apply
for peripheral patents of closely related compounds, thus protecting the
main application from imitation by competitors. This barrage of patent
applications may dissuade other companies from doing research closely
related to a recent discovery.
The Patent Term Restoration Act now pending in Congress is renewing
interest in the topic. If passed, it will provide an extension of up to
seven years of patents for products (including, but not limited to pharma-
ceuticals) which have lost part of their patent life in the regulatory
approval process. At least part of the motivation behind the proposal
springs from the contention that the regulatory process is becoming more
and more time consuming and burdensome, thereby reducing the incentive for
innovation.
Trademarks are another means of protecting markets. In Inwood v. lyes,
50 U.S.L.W. 4592 (June 1982) the Supreme Court recently recognized the
latitude generic manufacturers have in designing their products to look
like original brand names.
* United States v. Undetermined Quantities of Various Articles of the
Drug Bquidantin, 675 P.2d 994 (8th Cir. 1982).
3-21
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Tax Incentives
The Federal government also influences the pharmaceutical industry
through the enactment of tax incentives. Two incentives are of particular
interest: the incentive to attract investment to Puerto Rico and a recent
provision to stimulate R&D investment. Many of the larger pharmaceutical
companies have established subsidiaries in Puerto Rico to take advantage
of Federal and local income tax exemption policies. However, these
benefits have been reduced by recent tax legislation. This will result in
reduced profitability for plants located in Puerta Rico.
Recent action has also been taken to spur R&D investment. The
Economic Recovery Tax Act of 1981 included a provision allowing all
companies a 25 percent tax credit on R&D expenditures which represented an
increase over average expenditures during a base period.* The credit went
into effect July 1, 1981, and will continue through the end of 1935. It
is too early to assess its effectiveness in achieving its goal.
Other Involvement
The pharmaceutical industry is affected in a more indirect way by such
programs as Medicare and tfedicaid and Stats generic substitution laws. In
drugs dispersed under Medicare and Medicaid. Since generics are generally
response to the rising cost of national health care programs a Maximum
Allowable Cost (MAC) program was initiated in August 1976. The objective
was to lower ciie costs of these programs by setting maximum prices for
lower priced this type of action often benefits generic drugs at the
expense of brand name drugs.
In a separate effort, state generic drug substitution laws—such as the
one in New York—keep the cost of drugs down by requiring pharmacists to
substitute generic equivalents in prescriptions except when the physician
specifically requires a name brand. This also favors generic drugs.
VII. Foreign Trade
Pharmaceuticals compete in an international marketplace in which the
United States is the largest national participant. We are the largest
producer, largest consumer (with 16 percent of worldwide sales in 1975),
largest developer of ethical drugs (with 24 percent of all new drugs between
1961 and 1973) and second largest exporter of pharamaceuticals.
* In the first year the base period is the previous year. It is the
previous two years in the second and the previous three years for each
succeeding year of the credit.
3-22
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In 1977, the U.S. was second only to West Germany in the sales volume of
its pharmaceutical exports and second to Switzerland in net exports (i.e.,
exports minus imports). In that year, the three industry SIC groups had
exports amounting to $1.22 billion, representing nine percent of the total
value of shipments for that year of $13.6 billion. Table 3-14 presents the
exports by SIC group, over the period of 1977 to 1980. Since many countries
have tariffs or other barriers which serve to discourage the import of
prepared Pharmaceuticals (so as to encourage local manufacturing activity),
most U.S. exports are ingredients and intermediate products to be formulated
and packaged abroad. Table 3-15 gives the value of imports for the years
1977 through 1980. Exports have exceeded imports by more than 85 percent in
each of the four years. The largest class of imported products was bulk
antibiotics (part of bulk medicinals and botanicals) constituting 13 percent
of all imports in 1980. Another export characteristic is the large number
of Pharmaceuticals that are not marketed in the United States*. In some
instances the market potential for the product may be too limited and in
other cases the approval process for sale in the U.S. (such as drugs for
tropical diseases) has not been completed.
Most U.S. exports are sent to western Europe, with lesser amounts sent
to Japan and Latin America (see Table 3-16) . As with exports, most of our
imports come from Western Europe (see Table 3-17). Japanese imports have
been growing and are expected to increase significantly over the next
several years.
Over 40 U.S. companies operate branches or subsidiaries abroad to
manufacture and package products for local distribution. Many of these
products have no U.S. market. In 1977, the total sales volume of U.S.
subsidiaries was $4.9 billion. This volume has been growing rapidly over
the past decade (more rapidly than domestic sales) and is expected to
continue in the near future. Several foreign corporations have established
operations in the U.S. A 1976 Commerce Department survey reported that
these subsidiaries tallied U.S. sales exceeding $1.3 billion (about ten
percent of U.S. consumption). In addition, many more U.S. companies are
owned in part by foreign interests. (As shown in Table 3-8, roughly 10
percent of the companies on the 308 Survey have greater than 10 percent
ownership by foreign interests.)
VIII. Summary
The U.S. pharmaceutical industry has been defined, for the purposes of
this study, as all establishments producing products classified in SICs
2831, 2833, or 2834 plus all establishments producing other pharmaceutical
products classified elsewhere. Since this industry definition extends
beyond the scope of conventional sources of information, some sectors of
* According to a 1976 report by Delphi Marketing Services Inc., three
out of every four drugs synthesized in the U.S. are not marketed here.
3-23
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Table 3-14
Value of Pharmaceutical Exports
(Millions of current dollars)
1
1
Year 1
1977
1978
1979
1980
I SIC 2831 1 SIC 2833 I
Total Pharma- 1 iMedicinals/ 1
ceuticals 1 Biologicals 1 Botanicals !
1463.1 138.5 1024.7
1446.7 187.4 924.1
1634.1 295.5 999.2
1966.0 387.5 1157.4 (
SIC 2834
Pharmaceutical
Preparations
299.9
335.2
339.4
421.1
Source: U.S. Department of Commerce
Table 3-15
Value of Pharmaceutical Imports
(Millions of current dollars)
Year
1977
1978
1979
1980
1
1 Total Pharma-
1 ceuticals :
597.2
781.1
810.2
903.4
1 SIC 2831
1
1 Biologicals
7.1
9.2
9.0
j 15.3
I SIC 2833
IMedicinals/
I Botanicals
556.1
722.2
744.5
, 826.5
1 SIC 2834
1 Pharmaceutical
i Preparations
34.0
49.7
56.7
, 61.6
Source: U.S. Department of Commerce
3-24
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Table 3-16
World Distribution of U.S. Exports in 1980
Export Value (MM $)
I I Latin 1Western I i Other I Other !
SIC Class iCanadaI America I Europe I Japan 1 Asia I World ! Total
Biologicals 23.3 38.7 200.2 99.4 15.2 10.6 387.5
(2831)
Medicinals and 69.6 173.1 604.5 160.9 71.0 78.3 1157.4
Botanicals
(2833)
Pharmaceutical 49.8 61.1 109.0 80.0 76.9 44.2 421.1
Preparation
(2334)
Total 142.7 272.9 913.7 340.3 163.1 133.1 1966.0
Source: U.S. Department of Commerce
Table 3-17
World Distribution of U.S. Imports in 1980
SIC Class
Biologicals
(2831)
Medicinals and
Botanicals
(2833)
Pharmaceutical
Preparation
(2834)
Total
Import Value (MM $)
1 Latin IWesterni I Other i Other I
Canada I America 1 Europe 1 Japan 1 Asia 1 World 1 Total
3.8 0.1 10.2 0.7 0.2 0.2 15.3
15.3 28.9 565.9 113.7 29.2 68.0 326.5
0.9 0.4 54.4 3,3 2.4 0.2 61.6
20.5 29.4 630.5 122.7 31.8 68.2 903.4
Source: U.S. Department of Commerce
3-25
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the industry lack complete data. Based on the U.S Census of Manufactures
data for pharmaceutical establishments classified in the three SICs (2831,
2833, and 2834), the total value of shipments in 1977 was $14.2 billion
with value added equal to $9.9 billion. Lack of data prevents an estimate
of shipments for other establishments covered by the industry definition.
The industry cost structure is characterized by the large proportion
of sales revenue directed toward R&D and marketing, along with substantial
profit margins. Marketing alone accounts for roughly 35 percent of the
sales dollar with much of chis aimed at the medical professions. The
industry also invests heavily in R&D which is essential for the
development of new products and opening of new markets. This innovation,
with the protection provided by patents, has contributed to after-tax
profits between two and three times greater, as a percentage of sales,
than the average for all industries.
The 308 Survey of the pharmaceutical industry consists of 464
establishments owned by 243 companies. The mean 1980 company sales was
$1.0 billion.*
All of the 11 major market areas identified experienced growth between
1972 and 1977. The major areas of growth were vitamins, nutrients, and
hemantinics. The areas of least growth were active and passive immunization
agents and preparations affecting parasitic and infectious diseases.
Other important aspects of the pharmaceutical industry are its
relationship with government and its multinational character. In addition
to the role of the patent system, the industry is also influenced by the
FDA. While this relationship serves to protect consumers, it increases
the cost of bringing drugs to market. Foreign involvement in the U.S.
pharmaceutical industry and U.S. involvement in world pharmaceutical
markets are signficant. In 1977, the U.S. was the largest consumer and
the second largest net exporter of Pharmaceuticals in that year.
* As compared to Census data, the 308 Survey has a greater percentage
of large establishments.
3-26
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Section 4
Economic Impact Methodology
This section presents the methodology, including basic assumptions and
data sources, used in the analysis of the economic impact of the proposed
regulations on the pharmaceutical industry. First, the basic analytic
framework is presented, followed by a discussion of the actual impact
measures used.
Basic Analytic Framework
The usual measures of the economic impact of a regulation include:
changes in price and quantity produced, plant closures or reductions in
output and the resulting changes in the employment levels, and changes in
the profitability of the firms. Using a demand/supply analysis for each
product sector of an industry is a desirable method to produce a base case
forecast of price, output, revenues over costs, and capacity utilization for
each product sector in the absence of regulations. By adding the treatment
costs associated with a specific regulation to the supply curve, the effects
of the regulation can be forecast.
This approach was not possible for the Pharmaceuticals industry for
several reasons. First, price determination in the standard demand/supply
analysis assumes a competitive market. Due to patent protection and the
need for prescriptions, a large portion of the ethical drugs market is not
competitive. Second, neither process economics nor plant- specific
production costs are available for pharamaceutical production. An
alternative source of information on the cost of production might be the
U.S. Census of Manufactures. However,-marketing and research and
development (R&D) expenditures are extremely large for this industry, making
forecasts of future supply functions difficult since they are not simple
cases of present supply functions inflated by appropriate indices. Future
supply also will be influenced by changes in the Food and Drug Administration
(FDA) regulations and procedures, and possible changes in the patent laws
extending the life of a pharmaceutical patent.* Third, the future demand for
a product group is not a simple extrapolation of past growth rates but also
is dependent on the development of new drugs and new uses for existing
drugs. Therefore, this assessment of the economic impacts focuses on current
conditions, with modifications to reflect expected changes in demand and
supply over the next several years.
Assessment of Economic Impacts
In place of a complex model of pharmaceutical production and sales, a
two-step analytical procedure was employed. The first step was to screen ail
plants to identify those which were likely to experience a significant impact
* See Section 3, Industry Profile, for a more complete discussion.
-------
from the Proposed Regulations. This step consisted of comparing the estimated
treatment cost to estimated sales for each plant. Those plants whose costs
exceeded one percent of sales moved on to the second step, a detailed analysis
to determine their ability to comply with the Proposed Regulations.* The
screening and financial analysis was performed separately for each Proposed
Regulation, and for the combined costs of regulations.
Sources of Information
Host of the information used in the economic impact analysis was
collected from publicly available sources. Additional information was
provided by the Technical Contractor and from the technical 308 Survey. The
Technical Contractor provided estimated treatment costs for each plant under
each regulatory option analyzed.
The economic data can be grouped into three major types: plant-
specific data, company data, and industry-wide data.
Plant-Specific Data
Employment for each plant was provided by the 308 Survey. Sales for
most plants were provided by Economic Information Systems, Inc. (SIS).
For the few plants which belong to single establishment firms and were net
covered by EIS, plant sales were provided by Dun and Bradstreet. Sales
for the remaining plants were estimated on the basis of employment. To do
this, a regression relating sales to employment was estimated for those
plants included in the EIS set, and this relationship was used to assign
costs to the remaining plants.
Information on the products produced at each plant came from a variety
of sources. The 308 Survey provided product information for some plants.
Another major source of product information was the 1979 Directory of
Chemical Producers, SRI International. In a few cases, this was supplemented
oy information found in two earlier studies by PEDCo Environmental.** Dun
and Bradstreet and state manufacturing guides (including Puerto Rico)
provided product information in some cases. For a very few plants, product
information was verified by telephone calls to the plants.
* The choice of one percent is discussed under Treatment Costs-to-Sales
Ratio, and the detailed analysis is discussed under Closure Analysis later
in this section.
** "The Presence of Priority Pollutant Materials in the Fermentation
Manufacture of Pharmaceuticals," and "The Presence of Priority Pollutants in
the Synthetic Manufacture of Pharmaceuticals."
4-2
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Company Data
The major sources of company-level financial data were annual reports
and/or 10-K reports. This information was supplemented by data from Dun
and Bradstreet and from various state manufacturing and industrial guides.
The International Trade Commission provided some information on which
firms produced what products. Additional information was collected from
the Physician's Desk Reference*, the Merck Index**, and various trade
publications'1" and market studies."*"1"
Industry-wide Data
General information concerning the industry, its history and its growth
prospects were collected from various academic studies of the industry, and
the trade publications and market studies mentioned above. An additional
source of industry information was the U.S. Census of Manufactures, SIC
groups 2831, 2833 and 2834.
Treatment Costs
The screening measure employs the annualized treatment costs. The
Technical Contractor provided estimated incremental treatment
costs, both capital and operating and maintenance (O&M), for each plant to
meet the requirements of each regulatory option analyzed. These costs
were based on model plant costs, scaled to meet the known characteristics
of the actual plant. For some plants, flow and concentration levels were
not known, and averages for the industry or subcategory had to be
used."1"1"1"
* Published by: Medical Economics Co., division of Litton Industries,
Oradell, NJ.
** Published by: Merck and Company, Inc., Rahway, NJ.
Among which are: Drug and Cosmetics, PMA Newsletter, American
Druggist, and Pharmacy Times.
Outlook for the Pharmaceutical Industry to 1985, 1977, Delphi
Marketing Services, Inc., and The Pharmaceutical Industry, 1979, Morton
Research Corporation.
A detailed discussion of the procedures employed in assigning
costs to plants can be found in: Development Document for Proposed
Effluent Limitations and Standards for the Pharmaceutical Manufacturing
?oint Source Category.
4-3
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Annualized treatment costs are derived by converting the capital costs
to an annual equivalent and adding this to the annual operating and main-
tenance cost. Capital costs are converted to an annual equivalent by
multiplying by a capital recovery factor which measures the rate of return
an investment must achieve each year to cover the cost of the investment and
maintain net earnings, including depreciation and taxes. A capital recovery
factor of 0.22 was calculated, based on a 10 year life for the treatment
equipment, a 13 percent cost of capital, and a five-year depreciation life
for tax purposes.
SPT Treatment Costs
The incremental treatment costs associated with the proposed BPT
regulation are based on the costs of removing cyanide from the wastestraams
of direct dischargers. Treatment costs were provided by the Technical
Contractor for the direct dischargers that indicated in the 308 Survey an
exposure of wastewater to cyanide during the production process. A small
number of plants indicated the actual cyanide effluent concentration on the
308 Survey, while most of the others noted only its presence or absence.
For those plants with complete data, the Technical Contractor calculated
estimates based on 308 wasteflow and loading data. For the plants
indicating exposure but not reporting effluent concentrations, the costs
were based on 308 wasteflow data and an average loading. To obtain the
total cost of compliance, the Technical Contractor then applied a proba-
bility weighting to this second set. In the set of plants which provided
cyanide effluent loadings, 24 percent needed treatment. Therefore, it was
assumed that the probability of any plant in the second set actually needing
treatment was 24 percent and for total cost of compliance, the second set
of costs was multiplied by 24 percent.
The incremental capital costs were annualized by use of a capital recovery
factor equal to 0.22.* Since the treatment costs were for 1978 and the sales
for 1979, treatment costs were increased by a factor of 10.88 percent to re-
flect the rising cost of pollution control equipment between 1978 and 1979.**
Both sales and costs would then be estimated for 1979 in 1979 dollars.
* See Appendix C for a detailed discussion of the derivation of the
capital recovery factor.
** Pollution control costs were separated into their component parts,
Eacn was inflated separately, based on price indices in the Fall 1980, Data
Resources, Inc., Chemical Review, and these were aggregated to obtain an
overall inflation index. The components, their share of the total cost, and
their price indices are:
Share of Price
Component Total Cost Indices
Power 0.17 19.6
Materials 0.06 3.7
Labor 0.07 8.3
Capital 0.70 9.2
4-4
-------
3CT Treatment Costs
The treatment costs assigned to the proposed BCT regulation are based on
the costs a piant would incur in order to achieve BCT from their existing
level of treatment. These costs were estimated on the basis of existing
treatment instead of BPT, since EPA is revising the BPT requirements. These
plant-level costs were inflated to 1979 dollars, and a capital recovery
factor of 0.22 was used to annualize the capital costs.
PSES Treatment Costs
Two options were considered for the proposed PSES regulations. One option
concerned the removal of cyanide and the second option the removal of cyanide
and volatile organic compounds. Costs were developed for both options and
both options were analyzed. The first option is the proposed regulation.
Cyanide Removal Costs. These were estimated in the same way as the BPT
costs. See that discussion.
Steam Stripping. Steam stripping removes volatile organic compounds by
passing steam through the wasteflow. Treatment costs were provided by tne
Technical Contractor for only those indirect dischargers that indicated
wastewater exposure to volatiles. Since roughly 90 percent of the plants
noting exposure had six or fewer volatiles in their wastestreams, no plant
was required to treat concentrations of less than 300 micrograms/liter.
Indirect discharging plants with wastewater exposure to volatiles are
divided into four groups. The first set is composed of plants which do not
need treatment. Either they reported concentration levels below the 300
micrograms/liter, or they reported no concentration levels but use treatment
technologies which would remove volatiles. The second group is comprised of
plants which reported flow and concentration levels, and needed treatment.
For these, costs are based on flow and concentration. The third set is com-
prised of plants which reported flow but no concentration. Concentration
data is not crucial, since steam stripping efficiency is not very sensitive
to loadings. The probability that any one plant in this set will need any
treatment is assumed to equal the likelihood found for plants which reported
flow and concentration. Twelve plants reported both, and six of these had
volatile concentrations which required treatment. Therefore, it is assumed
that each plant in this third set has a fifty percent probability of treat-
ment, and tne total cost of compliance for this set equals one-half the sum
of the costs for all plants in the set. The fourth set is comprised of
plants which reported neither flow nor concentration. Costs for these
4-5
-------
plants were estimated on the basis of the costs for similar plants* in the
third set. Again, the fifty percent probability was applied to these plants.
There are six plants in group two which need treatment. There are 63 plants
in group three and 19 plants in group four which may need treatment.
Applying the fifty percent probability factor to groups three and four,
gives an estimate of 47 plants needing treatment for volatile organics.**
Treatment Costs to Sales Ratio
The screening measure compares the annualized cost of treatment to the
annual sales of the plant since production costs were not available. If the
ratio of costs to sales is less than 1 percent, then the plant is assumed to
be able to finance the costs of the regulation and keep operating. In 1980,
pharmaceutical companies had an after-tax profit to sales ratio of 11.3
percent. This compares very favorably with profit to sales ratios of other
industry groups (see Table 4-1). Therefore, an increase in costs equal to
one percent of sales will leave their profit to sales ratios relatively
high. By using a relatively conservative screening measure, no plant with
significant impacts would be missed.
Table 4-1
Industry Profit: Levels
Ratio of After-Tax
Profits to_ Sales (1980)
All tManufacturing .048
Chemical and Allied Industries .063
Industrial Chemicals
and Synthetics .045
Drugs .113
Food & Kindred .040
Source: U.S. Trade Commission, Quarterly Financial Report for
Manufacturing, Mining, and Trade Corporations, fourth quarter 1980,
* The subcategories used were: Biological and Natural Extraction,
Chemical Synthesis, Formulation, and Biological plus Formulation.
** Calculated as: 6+(.5) (63) +(.5) (19)=47.
4-6
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Sales figures in 1979 were obtained from Economic Information Service
(EIS) for 237 plants, out of a total 464 plants. In some casesr these sales
data may be overestimates. Several plants, particularly large ones, manu-
facture a variety of products including nonpharmaceuticals. These other
product lines tend to be industrial organic and inorganic chemicals, pesti-
cides and dyestuffs. The sales figures for plants such as these will
include nonpharmaceutical plus pharmaceutical revenues. Thus the sales
would be overestimated and the economic impacts on the Pharmaceuticals
product group underestimated, assuming the treatment costs involve only the
pharmaceutical production and not the entire plant.
SIS sales data on the remaining 227 plants were not available to us.
Either 213 had assigned these plants to nonpharmaceutical SIC groups because
the majority of their sales are in a nonpharmaceutical area, or the plant
has fewer than 20 employees and thus is not included in the EIS data base.
Of the 227 plants, 27 belonged to single-establishment firms. For these
plants, since the plants and the firm are identical, sales data for the firm
as reported by Dun and Bradstreet were used. For the remaining 200 plants
sales were estimated based on regressions of sales on employment. Both
indirect and direct discharging plants were separated into four groups based
on production subcategory. Regression equations associating annual sales
and manufacturing employment were then calculated for each of these four
groups. Using the appropriate equation, sales as well as a lower 90%
confidence interval about the mean production were estimated for each
plant. Appendix A contains a detailed discussion of the procedure and the
regression results.
Closure Analysis
Additional information was collected about each plant identified by the
screening measure. This information was grouped into three sets. First
were characteristics of the parent firm, including its financial position,
its major lines of business, and the relative importance of Pharmaceuticals,
both currently and in the future. The second set included information about
the specific products produced by that plant and their relative competitive
position, such as patent protection and size and share of market. The third
set included information about what non-pharmaceutical products were pro-
duced at that plant and whether the pharmaceutical products were produced by
that firm at other locations.
Based on these plant profiles, a judgment was made as to the likely
reaction of the firm to effluent limitations. If the firm was in a position
to pass the costs on to the consumer, due to patent protection, then it was
assumed that the price would be increased and the plant would remain in
operation. If these costs could not be passed on; then a judgment was made
based on the above information, as to the ability of the firm to absorb the
4-7
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costs. This would be done to protect income levels or-because the plant was
necessary for company-wide production needs. The cpmpany's ability to
absorb the costs is also a function of the growth rate in sales of its
products.* In some cases, a production line might close while the rest of
the plant remains open. Foe some firms, moving production from one location
to another also might be an option.
*See Section 3 for a discussion of product group growth rates.
4-8
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Section 5
Economic Impact Analysis
Introduction
This section presents the results of the economic impact analysis,
discussed in Section 4, for the proposed regulations.* Total costs of com-
pliance are presented for each proposed regulation followed by a detailed
description of those plants with potentially severe impacts. Probable
responses by the potentially affected plants are also discussed.
The pharmaceutical industry data base contains 464 plants, all of which
were included in the Technical 308 Survey. The BCT and BPT analyses ex-
amined 60 direct dischargers while the PSES analyses considered 279 indirect
dischargers.
The plants included in the 3PT, BCT and PSES studies were, in part,
determined by the presence and quality of the wasteflow and pollutant
concentration data found in the 308 Survey reports. Many plants did not
provide flow and/or concentration information, and because both of these
data were necessary for estimating the treatment costs, the Technical
Contractor adopted an alternate costing strategy. Costs were estimated on
an "if needed" basis for those plants without complete flow and concentra-
tion data. The sum of those treatment costs was then weighted by a proba-
bility of needing treatment. This probability was calculated by taking
the ratio of plants definitely requiring costs (based on 308 data) to the
total number of plants for which complete flow and effluent data were
available. For example, 25 plants (out of the 34 reporting cyanide in
their wastestreams) reported complete data for flow and cyanide concentra-
tions. Of these, six required treatment. Assuming these plants to be
representative, a probability of 0.24 (6/25) was estimated and applied to
the sum of the treatment costs for the 9 plants without complete data.
Similarly, a weighting factor was estimated for the volatile organics
costs. It is important to note that the probability weight is used only
in computing total cost of compliance for those plants without complete
flow and concentration data, but not for the individual plant analyses.
For the individual plant analyses, the worst case assumption was made that
each plant would incur its total estimated cost.
Another point of clarification concerns discharge status. BPT and 3CT
regulations apply to direct dischargers while PSES regulations apply to
indirect dischargers. Zero dischargers, which include deep-well injec-
tion, are not covered by any of these regulations. Of the 464 plants in
the data base, seven plants had both direct and indirect waste flows.
*See Section 2 for a more detailed description of the regulations.
-------
The complete breakdown is as follows (D=Direct, I=Indiract, Z=Zero) :
D only = 53 D/I = 7
I only = 272
Z only =132 Total = 464
Based on the 308 data it was seldom possible to distinguish the relative
magnitude of process flow in each discharger category foe plants with
multiple discharge or to determine relative pollutant concentrations in each
wastestream. In cases of ambiguity, it was assumed that the entire waste
flow was discharged directly or indirectly, depending upon the applicable
regulation. This puts an upper bound on the cost of that regulation and is,
therefore, a conservative approach. (All costs and sales figures are in
1979 dollars.)
Best Practicable Control Technology Currently Available (BPT)
Total .Cost of Compliance
The incremental costs associated with the proposed revision in the BPT
regulation cover the discharge of cyanide directly into receiving waters.
Sixty plants discharge all or part of their wastes directly and are,
therefore, subject to this regu- lation. Of these, thirteen indicated
exposure to cyanide in their manu- facturing processes.* However, six
reported concentrations already meeting the maximum threshold value. Of
the remaining seven, five reported concentrations in excess of the
threshold for cyanide and two others did not give the concentration. For
the five plants with complete data, costs were computed directly. The
Technical Contractor also estimated costs for a sixth plant assuming that
it required treatment. As mentioned in the introduction, that cost will
be incurred with a proba- bility of 0.24. The probability is derived from
the ratio of the number of all plants with known cyanide exposure above
the allowable threshold to the number of all plants with known cyanide
exposure above or below the threshold The seventh plant was excluded
because the Technical Contractor determined that the wastewater exposed co
cyanide had a concentration below the threshold.
Total costs of compliance are computed as shown in Table 5-1. The
expected capital cost is $1.545 million and the expected annual cost is
$0.557 million.
*Four of the thirteen are multiple discharge category plants. In
addition to their direct discharges, two discharge indirectly, one has a
zero discharge component, and one has both zero and indirect components.
For the BPT and BCT analyses, these are all considered direct dischargers,
5-2
-------
Table 5-1. Computation of Total Cost of
Compliance for 3PT
(thousands of 1979 dollars)
i 1 I
Number 1 Capital 1 Annualized i
of Plants | Cost 1 Cost !
5 1,536 553
1 ( 35.5 . 18.9 !
Probability 1 Expected I Expected
of Incurring i Capital 1 Annualized
Cost 1 Cost 1 Cost
1.0 1,536 553
0.24 9 ( 4
Totals $1,545 $557
Plant Impacts
For each of the six plants, the annualized treatment cost (or cost of
compliance) was compared to annual sales. (For the plant with the 0.24
probability it was assumed treatment would be required.) The impact ratio
compares the annualized treatment cost to plant sales. If tnis ratio is
greater than one percent, then the impact is considered large enough to
warrant further analysis. These ratios are shown in Table 5-2. The
highest ratio is well below 1.0 percent. Therefore, there will be no
significant impacts due to the proposed BPT regulation.
Best Conventional Pollutant Control Technology (BCT)
Total Cost of Compliance
The proposed BCT regulation also applies to the same 60 direct
dischargers. Of these, 42 reported complete flow and concentration data
for conventional pollutants. Ten of this group exhibited concentrations
in excess of the proposed standards and would, therefore, incur treatment
costs. Eighteen plants reported only flow data. For these plants, costs
were estimated on an "if needed basis". That is, if the plant does dis-
charge conventional pollutants in excess of the standard, then the given
cost will be faced. (In fact, these costs are based on average loadings
so the actual cost may be higher or lower, though in the aggregate should
balance. Insufficient data exist to pinpoint which plants require treat-
ment.) The probability of needing treatment is calculated by oosecving
that 24 percent (ten out of 42) of the plants with complete data show
excessive concentrations of conventional pollutants. Assuming the same
ratio holds for the eighteen plants failing to report concentration data,
the 0.24 probability can be applied to the costs computed on an if needed
basis when estimating the total cost of compliance as shown in Table 5-3.
The expected capital cost is $16.8 million and the annual cost is $6.56
million.
5-3
-------
«»
acting One Percent or Sales
1 Ratio of Annualized Treatment
1 Cost to Annual Sales (Percent)
Plant I.D.
A
a
c
D
E
F
G
H
:
j
K
DD
L
M
N
0
t BPT 1
0.0++
0.0++
0.0++
O.Q++
0.0++
0.22++
0.25++
0.0+-t-
0.0++
Q.O++
0.0-M-
0.0
0.065++
0.42+-*-
0.14+-*-
0.003-*-
1 1
BCT 1
5.78++
3.00+
2.95++
2.93++
2.37+
2.31 +
1.77++
1.73+
1.22+
1.12+
1.10++
1.02+
Q.98++
O.Q++
0.0++
0.01 +
1
BPT&BCT
5.78
3.00
2.95
2.93
2.87
2.53
2.02
1.73
1.22
1.12
1.10
1.02
1.04
0.42
0.14
0.01
TQ.24 probability of cost.
1.0 probability of cost.
5-4
-------
Table 5-3. Computation of the Total Cost of
Compliance for the Proposed BCT Regulation
(thousands of 1979 dollars)
111 11 1 Expected No.
1 | (Probability 1 Expected I Expected I of Plants
Number* I Capital 1Annualizedlof IncurringI CapitalI Annualizedl Needing
of Plants 1 Cost I Cost 1 Cost 1 Cost 1 Cost 1 Treatment
10
13
13,096
j 15,511 (
5,164
5,334 (
1.0
0.24
13,096
1 3'723 i
5,164
1,400
10
4
Totals $16,820 $6,560 14
* Before applying probability factor.
Plant Impacts
Taole 5-2 lists the twelve plants whose cost to sales ratios under the
proposed BCT regulation are greater than one percent. Plant L is also
included because the combined ratio from BPT and BCT costs exceed one
percent. Each of these are examined at greater length in the following
section.
Closure Analysis
The first plant, Plant A, is owned by a large multi-national organic
chemical firm. In addition to manufacturing active ingredients for pre-
scription drugs, this plant produces plastics, resins, and pesticides.
Demand for its pharmaceutical products is somewhat inelastic since they
are intended for prescription drugs. However, Plant A may close pro-
duction lines of more vulnerable products in order to reduce costs.
Plant B is owned by a much smaller company; seventy people are employed.
The plant produces cat and dog vaccines and is owned by a company which
specializes in animal vaccines. Manufacturing also takes place at the
company headquarters which was not included in the 308 sample. If this
other plant bears lower costs, management may decide to transfer all
operations to the main office and close Plant B.
Plant C shows a cost-to-sales ratio of nearly three percent. The
plant is owned by a very large (over 30,000 employees) pharmaceutical
company. This company also owns another plant with a cost-to-sales ratio
above one percent, Plant G. According to one of the firms' recent annual
5-5
-------
reports, the company earns a return on investment (profits divided by
assets) in excess of fourteen percent. The plants themselves are both
large (approximately 200 manufacturing employees each in 1976) and produce
a very widely prescribed pharmaceutical for which the firm holds the
process patent. Plant C also has special facilities for producing another
pharmaceutical which was among the 30 most prescribed drugs in 1980,
Because of this, and the company's size and profitability, it is unlikely
that these plants will close due to the proposed regulation.
The plant with the fourth highest cost-to-sales ratio, Plant D, is
owned by a very large (over 40,000 employees) organic chemical firm. It
produces a wide range of products, particularly pesticides and
agricultural chemicals. It also produces animal feed additives. Given
its size and diversification of products it is unlikely that the
establishment will shut down completely. However, some of its production,
particularly the more common drugs, might be shifted to other company
plants.
The impact on Plant E is uncertain, although closure is unlikely. It
is owned by a large chemical company which has been moving into the
pharmaceutical field by purchasing existing operations, with plans to
continue expanding in this area. Although this plant produces the less
profitable over-the-counter drugs, the recent purchase of Plant £ cy its
current parent company coupled with the company's interest in breaking
into pharmaceutical markets will probably keep the plant open, Although
potential treatment costs may discourage the company's interest in
additional acquisitions, current operations will most likely be supported.
Plants F and L are in a similar position to Plants C and G. They are
large facilities, each with over 500 manufacturing employees in 1976, and
are owned by a large firm (over 25,000 employees) specializing in pharma-
ceuticals. The firm has had a rate of return on its assets of over thir-
teen percent in recent years. Even if the entire cost of treatment comes
out of profits, which is unlikely given the market strength of the company
and its patent rights to some products, the company will probably keep
both plants in operation.
Plant H (G was discussed with C) is also part of a large pharmaceutical
firm (over 20,000 employees). Opened in the 1960s, it employed between 50
and 100 manufacturing employees in 1976 according to the 308 survey. Its
primary line of business is the manufacture of glass containers (SIC 3221)
for packaging Pharmaceuticals and cosmetics. Since this plant probably
provides containers for other plants in the company, the plant is not
expected to close.
Another large pharmaceutical company owns Plant I. Over one hundred
manufacturing employees chemically synthesize and formulate the establishment's
main products~-laxatives, antacids, and milk of magnesia. The market for
these products appears steady as does the firm's position in that market.
No changes in operations are expected.
5-6
-------
Plant J has a cost-to-sales ratio just over the threshold (1.12 percent).
Located in Puerto Rico, this plant is one of many owned by a chemical company
employing more than 10,030 people. The plant itself is not large, with only
20 manufacturing employees reported in 1976, and for that reason it may
experience some difficulty complying with the proposed regulation. However,
the favorable tax status available in Puerto Rico, combined with the marginal
burden of treatment costs (1.12 percent of sales) should keep the establish-
ment open. (Recent legislation has reduced some of the Puerto Rican tax
advantage. As a result, some operations in Puerto Rico may discontinue. Such
a closure would be a "base case" closure, not due to the proposed regulation.)
A medium sized firm with over 2,000 employees owns Plant K also located
in Puerto Rico. Manufacturing employment was approximately fifty in 1976,
one year after opening. Manufacturing at the plant involves formulating
toothpaste and other dental products for sale in the Puerto Rican, mainland,
and international markets. Closure is unlikely for largely the same reasons
as Plant J: low cost-to-sales ratio (1.10), a strong parent firm and tax
exempt status.
Plant DD has a cost-to-sales ratio slightly greater than 1.0 percent.
This is a very large plant, employing well over 1,000 workers; and it is
owned by a large chemical and pharmaceutical company. Given the low ratio
and the size and strength of the owner, currect operations will continue.
All but three plants should be able to continue operations unchanged
under the proposed regulation. Two plants may choose to close down a
particular production line or shift it to another facility (Plants A and
D). Only one plant (Plant B) is in danger of closing.
Combined Effect of Proposed BPT and BCT Regulations
Due to the relatively small costs associated with the proposed BPT
regulation, adding them to BCT costs does not change the situation
discussed above. Table 5-2 presents the cost-to-sales ratios for the
combined BPT and BCT costs.
Employment Losses Due to BPT and BCT Regulations
Table 5-4 shows total plant employment and percentages for all 464
plants, for all direct dischargers, and for those plants with the greatest
potential for production line or plant closure under the combined regu-
lations. Employment figures are from the 1976 and 1978 308 surveys. As a
percentage of all manufacturing employees the maximum loss is 0.13 percent
(total industry includes all 464 plants). As a percentage of manufac-
turing employement in direct discharging establishments, the maximum loss
is 0.59 percent.
5-7
-------
Table 5-4. Maximum Loss of Employees Due to
Proposed BPT and BCT Regulations
Number of
Manufacturing
Employees
Percent of I Percent of
All Manufacturing 1 all Direct
Employees I Dischargers
Total: All types
of dischargers 112/000
Total: All direct
dischargers (60 plants*) 24,400
Possible plant
closure: Plant B
Possible production
closure: Plant A
Possible production
line shift or closure:
Plant D
45
73
25
0,04
0.07
0.02
0.18
0.30
0.10
Totals
143
0.13
0.59**
*t)irect dischargers are defined here as those plants with discharge
status of direct, or multiple discharges including direct.
** Does not sum due to rounding.
The industry employment sum does not include employment figures for
nine plants due to missing data while the direct discharger sum is missing
two figures. As a result, the percentage values represent upper bounds
and are, therefore, conservative estimates.
Price Changes
Due to the lack of data and the complexity of the pharmaceutical
industry, it was not feasible to estimate price elasticities. Instead, it
was assumed that for products witn patent protection, the costs would be
completely passed through as price increases without loss in sales volume.
For some plants, product information was availaole. However, the actual
output levels for these products were not available. Therefore, a specific
price increase due to a cost increase could not be estimated. As an ex-
treme position, it was assumed that all firms would transfer the entire
cost of the regulation into higher prices. The annual cost of BPT and BCT
is about $7.1 million (= 0.557 -t- 6,56). Given estimated total sales of
S3.9 billion for the 60 direct discharging plants, the cost-to-sales ratio
for BPT and BCT combined would then be:
$7.1 million/$3,900 million =0.18 percent
5-3
-------
Clearly this is very rough and should be taken as no more than an order of
magnitude estimate. Total sales include some non-pharmaceutical sales which
may cause this to be an underestimate. Conversely, not all firms will be able
to shift their costs into price increases. In addition, this estimate may not
accurately reflect the situation in different product groups because some may
have effluent streams which are more difficult and expensive to treat than
others. Sufficient data are not available with which to determine those
specific types of products that may bear disproportionate costs.
Balance of Trade Impacts
As described in Section 3, "Industry Profile", the United States is
the second largest exporter of Pharmaceuticals. In 1977, U.S. exports
represented about 9 percent of the total value of shipments. The impact
of these propsed BPT and BCT regulations should be very small given the
small impact on prices estimated above.
Best Available Technology Economically Achievable (BAT)
Since the technology controls that are the basis for the combined 3PT/
BCT limitations can also serve as the basis for the 3AT regulations, there
are no incremental costs. Therefore, there are no additional economic
impacts beyond those described above.
Pretreatment Standards for Existing Sources (PSES)
Two options were considered for PSES. One was cyanide destruction,
the other was cyanide destruction and removal of total toxic volatile
organics. Out of the sample of 464 plants provided by the 308 Survey, 279
discharge at least part of their wastes to POTVJs (indirect discharge) and
are subject to PSES regulations. (This includes plants with multiple
discharges which include indirect. See page 5-2 for complete breakdown.)
Total Cost of Compliance; Cyanide Control
Cyanide destruction costs were provided by the Technical Contractor for
plants with direct and/or indirect discharge components. In many cases
where multiple discharge status was given it was impossible to distinguish
the relative volumes of flow and the relative concentrations of cyanide in
each wastestream. As such, all plants with a direct discharge component
were considered under the BPT cyanide regulation discussed earlier. To
avoid underestimating total costs for the PSES cyanide regulation, seven
plants with multiple discharge status were also included here. Only one of
these seven actually had treatment costs (with 0.24 probability). The
drawback of this approach is that the costs for this one plant are counted
twice rather than being allocated to each regulation.
5-9
-------
Of the 279 plantsf twenty indicated exposure to cyanide in their
manufacturing processes. Twelve reported actual effluent concentrations,
with only one of these exhibiting a concentration greater than the allowable
maximum. Costs for the eight plants without concentration data were
estimated by assuming each had a concentration of cyanide equal to the
average of three direct discharging plants analyzed in great detail by the
Technical Contractor, However, based on the ratio of all plants with known
cyanide concentrations above the threshold to all plants with known cyanide
concentrations, it was assumed that those eight plants would incur costs
with a 0.24 probability. Therefore, adding the cost for the single plant
known to incur costs to the sum of the estimated costs of the eight plants
multiplied by 0.24 yields the figures for cost of compliance shown in Table
5-5. The expected capital cost is $0.781 million and the annual cost is
$0.292 million.
Table 5-5. • Computation of Total
Cost of Compliance for the PSES Cyanide Regulation
(thousands of 1979 dollars)
Number*
of
Plants
1 1
1 1
i Capital I
1 Cost !
1
1
Annualized 1
Cost 1
Probability
of
Incurring
Cost
I 1
I Expected
1 Capital i
1 Cost
[Expected No
1 Expected i
i Annual izedl
1 Cost !
or Plants
Needing
Treatment
582
211
1.0
582
211
I
830
336
0.24
199
31
Totals
* Before applying probability factor.
$781
$292
Plant Impacts; Cyanide Control
The annualized treatment costs of cyanide removal were compared to
annual sales for each plant. Since it was not possible to determine which
of the plants with probabilistic costs would actually bear them, the
conservative assumption that each plant would bear its estimated cost was
used for this part of the analysis. The nine plants which might incur
costs for cyanide destruction all have very small cost-to-sales ratios
(see Table 5-6). None is above one percent, with the greatest being equal
to Q.18 percent.
5-10
-------
Table 5-6. Impact Ratios for Indirect Discharging
Pharmaceutical Plants
Plant I.D.
0
P
Q
R
S
T
U
V
W
X
Y
Z
AA
BB
CC
I Ratio
i Costs
1 Cyanide 1
1 Destruction 1
0.003*
0.18*
0.17**
0.083*
0.050*
0.033*
0.032*
0.017*
0.015*
0,0**
0.0**
0.0**
0.0**
0.0**
0.0**
1 1
of Annualized Treatment
to Annual Sales (Percent)
Cyanide and Total Toxic
Volatile Organics
0.003+++
0.57++
0.59++
0.083+++
0.18++
0.09++
0.13++
0.17 +
0.07++
3. 10++
2. 50++
2.34+
2.00+
1.40+
2.34+
*0.24 probability of cost incidence.
**Treatment for cyanide is required.
+no flow or concentration data, 0.5 probability of cost incidence for
volatile organics portion.
++no concentration data, 0.5 probability of cost incidence for volatile
organics portion.
+++complete data, showing treatment requirement for volatile organics
portion.
5-11
-------
Since costs for eight of the nine were estimated assuming average
concentrations, it is likely that some of these, if treatment is needed,
are underestimated. However, since costs would have to increase by a
factor of greater than 5.5 for even Plant P to reach a one percent cost-
to-sales ratio and, except for Q, there is only a 24 percent chance of
expenditure being required anyway, this is not likely to be a problem.
Therefore, no significant impacts, including closures, are expected from
the proposed PSES cyanide regulation.
Total Cost of Compliance; Cyanide and Total Toxic Volatile Organics
Contro1
The second PSES option would place limitations on the discharging of
total toxic volatile organic chemicals, while maintaining the cyanide
limitations of the first option. The estimated compliance costs for this
option are the sum of the option one costs and the costs of removing total
toxic volatile organics. Of the indirect dischargers, 105 have noted the
presence of volatile organics in their manufacturing processes. However,
twelve (12) report current use of treatment technologies—aeration, steam
stripping, etc.—which remove volatile organics to some extent and it was
assumed that no further treatment would be required at these plants. Five
(5) additional plants showed concentrations of volatile organics below the
maximum allowed by the proposed regulation. This left 88 plants which
might incur steam stripping costs. As was the case for cyanide, only a
few plants—six (6) in this case—reported both flow and concentration
data. Nineteen (19) of the remaining plants lacked both flow and
concentration data while 63 reported flow data, but no information on
concentration.
The Technical Contractor computed costs for the two groups (82 = 19 +
63)without complete data, assuming that treatment would be needed. Steam
stripping costs were estimated as a function of wasteflow for all plants
with flow data. This approach was reasonable because the cost of removing
volatile ocganics is relatively independent of initial concentrations.
For the nineteen plants without any data, costs were taken as the average
of costs for plants in the group of 63 utilizing the same types of
production processes (based on production subcategory, see Section 4.)
The costs for the 82 plants are on an "if needed" basis. The probability
of need was estimated at 0.5 after noting that of twelve (12) plants with
known flow and concentration data, six (6) required treatment. The
expectation is that approximately 47 plants will incur costs (6 plus
approximately half of the 32 plants). Total costs of compliance with the
total toxic volatile organics control can be calculated as zhe costs for
the six (6) known plants plus half of the costs for the remaining 82
plants (see Table 5-7.)
5-12
-------
Table 5-7. Computation of the Total Cost of Compliance
for the PSES Removal of Total Toxic Volatile Organics
(thousands of 1979 dollars)
I 1 i Probability I i I Expected No.
Number*! I I of I Expected I Expected 1 of Plants
of I Capital I Annualized 1 Incurring I Capital I Annualizedl Needing
Plants 1 Cost 1 Cost 1 Cost 1 Cost ! Cost I Treatment
6 460 , 690 , 1.0
63 3970 6080 0.5
19 520 . 890 , 0.5
Totals
j 460
, 1985
260
$2,710
j 690
t 3040
445
$4,180
6
31.
9.
47
5
5
* Before applying probability factor.
Therefore, the total cost of compliance for this second option (sum of
cyanide destruction and steam stripping costs) would be:
Capital Cost
Annualized Cost
$3.48 million
$4.49 million
Plant Impacts; Cyanide and Total Toxic Volatile Organics Control
Six plants have cost-to-sales ratios greater than one percent under
this second option (see Table 5-6). The highest is for Plant X, with a
cost-to-sales ratio of 3.10 percent. The other five facilities have
cost-to-sales ratios ranging from 2.50 percent to 1.40 percent.
Each of these six plants lacked either concentration or flow data, or
both. Costs for plants Z, AA, BB, and CC were based on average costs of
plants in their subcategories while the costs for Plants X and Y were
estimated with the approximate flow-cost relationship described earlier.
Because of this, two factors mitigate these potentially high impacts.
First of all, there is only a fifty percent chance that these plants will
incur costs at all. Secondly, the highest cost-to-sales ratio of a plant
with known costs (i.e., complete flow and concentration data) is 0.35
percent. This indicates that the estimated costs may be too high.
5-13
-------
Closure, Analysis: Cyanide and Total Toxic Volatile Organics Control
The plant with the highest cost-to-sales ratio, plant X, is owned by a
large company (over 9000 employees) and is located at the firm's corporate
headquarters. The facility had 873 manufacturing employees involved in
the production of Pharmaceuticals in 1976. Given the large size of the
facility and of its parent company, it is unlikely to be closed by the
regulation despite its relatively high cost-to-sales ratio. There is a
possibility that this plant may respond to regulatory costs by shifting
production away from certain processes and into others with lower
compliance costs, however, no change in employment is expected.
Plant Y is a medium-sized facility with approximately 400 manufacturing
employees. The plant is owned by a chemical corporation and appears to
manufacture Pharmaceuticals as one of many types of products. This is
partially based on the report of just 44 employees involved in pharma-
ceutical manufacture in the 308 Survey. Though it is unlikely to close,
management may choose to avoid regulatory costs by closing down pharma-
ceutical production lines and expanding production of other goods.
Plant 2 is also owned by a small company, but should be able to comply
with the regulation. It is primarily a chemical company and is not solely
dependent on its pharamceutical products. Its in-house research activi-
ties should also help the facility adjust its activities in response to
the regulation.
The plant with the next highest cost-to-sales ratio, Plant AA, is a
small establishment (six manufacturing employees) producing bulk Pharma-
ceuticals affecting the central nervous system. Subsequent telephone
conversations by EPA with the company indicated that no costs would be
incurred because process operations would be altered in response to the
regulation.
The next plant, plant BB, is also small. It employs only 10 people
according to a 1982 State Industrial Guide. This plant is expected to
remain open because it produces enzyme and clinical diagnostic products
that are sufficiently specialized for distribution to be worldwide. This
product specialization should allow for most, if not all, of the treatment
costs to be passed through in higher prices. In addition, the plant's
cost-to-sales ratio is less than two percent.
The final plant, plant. CC, is owned by a small, well-established
pharmaceutical company producing liquids, ointments, and tablets.
Although the initial economic analysis showed that costs will represent
2.43 percent of sales, subsequent data provided by EPA indicated that the
wastewater flow discharged to a POTW was much less than the flow
originally used and so the costs would be negligible.
5-14
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Under this second proposed PSES regulation, six plants may have cost-
to-sales ratios of more than one percent. No plants will close and
pharmaceutical production may be curtailed at one large, multi-product
facility (Plant Y). Since costs will be incurred by this plant with only
a 0.5 probability, this is a worst case scenario.
Employment Losses; Both Options
Since there are no expected closures under the first option, there is
no expected employment impact. Total employment for all plants and for
the plant which might close under option two are shown in Table 5-8.
Employment figures are from the 1976 and 1978 308 Surveys. In all cases,
employment lost, as a percent for all facilities or for indirect dis-
chargers only, is extremely small. If the line closure were to take
place, it would affect 44 employees or 0.05 percent of the total manufac-
turing employment at indirect discharging plants or 0.04 percent of all
pharmaceutical manufacturing employment.
Table 5-8. Plant Employment Impacts—PSES Regulation
for Steam Stripping and Cyanide Destruction
i I | Percent of
I Number of 1 Percent of All 1 Indirect
I Manufacturing I Manufacturing I Discharger's
1 Employees 1 Employees .1 Employees
Total: All types
of dischargers 112,000
Totals All indirect
dischargers
(280 plants) 93,500
Possible Line Closure:
Plant Y |
Totals |
44 |
44 ,
0.04 |
0.04 |
0.05
0.05
Price Changes; Both Options
As discussed above in the section on the combined effects of the
proposed BPT and BCT regulations, it was not possible to estimate price
increases for specific products. As an extreme case, it was assumed that
the total cost of the regulation would be passed on by firms in the form
of higher prices. Given total estimated sales for the 279 indirect
dischargers of $15.7 billion, the total cost-to-sales ratio for PSES
option two would be:
$4.5 million/SIS,700 million = 0.03 percent
5-15
-------
The price impact of option one would be negligible. This is a very rough
estimate. Total sales include some non-pharmaceutical sales, while not
all firms can shift their costs forward. In addition, the treatment costs
may be concentrated in certain product groups. However, it appears that
any price increases are likely to be small.
Balance of Trade Impacts
Given the very small price impacts of either of the PSES options,
there is likely to be little or no overall impact on the pharmaceutical
balance of trade. AS with the SPT and BCT proposed regulations, this
conclusion may not hold for specific Pharmaceuticals where the price
impact and competition may be significantly greater than the overall
levels.
Resource Conservation and Recovery Act (RCRA)
RCRA costs were not included in any of these analyses. The sludge
generated as a result of the existing BPT limitations, as well as that to
be generated as a result of these regulations, is not hazardous and
therefore not subject to RCRA regulation disposal. Some sludges from
metal precipitation treatment may in some cases be hazardous, out the
amount of metal precipitation anticipated from the treatment of pharma-
ceuticals wastewater is expected to be quite small. These sludges will
have very little or no impact on the RCRA disposal requirements of the
regulated plants.
5-16
-------
Section 6
New Source Performance Standards (NSPS) and
Pretreatment Standards for New Sources (PSNS)
NSPS
The New Source Performance Standards for direct dischargers are more
stringent than the standards for existing plants. The 30 day average
effluent limitations for NSPS are shown below:
Proposed NSPS
BOD5 31 mg/1
TSS 72 mg/1
COD 449 mg/1
Total Cyanide 0.375 mg/1
Except for cyanide, these standards are more stringent than the BPT/BCT/
BAT limitations; therefore, they may have a greater impact on new sources
than on existing sources, placing them at a disadvantage. The incremental
NSPS costs, as provided by the Technical Contractor, appear in Table 6-1.
Costs are shown for plants that produce in only one of each of tne four
subcategories (A, B, C, and D) along with the cost for an average sized
plant of a combination of subcategories. Costs for an average mixed cate-
gory plant are large because diversified plants tend to be larger,
Table 6-1. Incremental Costs to Meet
New Source Performance Standards*
(1979 dollars)
Subcateqories*
1,
A
656,
330,
690,
i
1
1
000
000
0001
B
240,
32,
85,
000
000
000
1
1
1 c
1,070,
161,
I 398,
1
1
I
000
000
000 !
D
300
34
99
I Average
1 Mixed
! Categories
,000
,000
,000 |
3,660,
632,
1,440,
000
000
000
Capital Cost
Operating Cost
Annualized Cost
+Costs provided by the Technical Contractor. The first four are based on
an average plant for each subcategory and the Contractor's Engineering Report,
with basic costs as calculated by Catalytic's computational model. For a
model plant which represents the average plant for the entire industry, the
last column is used.
*Subcategories: A-Fermentation, B-Biological Extraction, C-Chemical
Synthesis, D-Formulation.
-------
while the plants used for costs of Subcategories A, B, C, or D alone tend
to be smaller specialty plants.
Based on announced new construction, it is estimated that the capital cost
of building a new formulating facility (Snbcategory D) is approximately 330
million and the capital cost of a new manufacturing facility is approximately
$55 million. The capital costs of providing NSPS treatment in a formulating
facility is estimated to be $300,000. Therefore, treatment costs increase the
cost of building a new formulating plant by about one percent (.3 x 106/30 x
106). it was not possible to determine which subcategories should be
assigned to the announced manufacturing facilities. However, the average
treatment capital cost for the three manufacturing subcategories is $989,000.
This would increase the construction costs by about 1.8 percent (.989 x
10^/55 x 10$).*
Expansion in this industry over the next few years is not expected to
be large, even if no new water quality regulations are imposed. Capacity
utilization in the late 1970's was low due to rapid expansion during a
period of low growth in output. Capacity utilization in 1977 was only 72
percent, as compared with 77 percent in 1976 and 80 percent in 1974.**
Expected low levels of expansion are further supported by an analysis
of recently announced expansions and new plant construction.*** For pur-
poses of this study, facilities were categorized as follows: research and
development, manufacturing, formulating, and unspecified. There were 31
announced expansions and new facilities, with completion dates ranging
from 1981 through 1985. However, twelve of these were for research and
development facilities, including four which were multipurpose. Research
and development facilities produce very little wastewater and were elimi-
nated from the subcategories specifically studied. Of the 23 remaining
announcements, the largest group is manufacturing, with 14 new or expanded
plants. Two of these also have R&D facilities. In comparison, formulat-
ing will be experiencing very little expansion, with only five new or
expanded facilities announced. Two of these also include research and
development facilities. For the remaining four announcements, the use of
the facility was not specified.
Usually it is not possible to determine from these announcements if a
facility will qualify as a new source or an expansion of an existing
source, according to EPA criteria. Clearly, some of these will be exist-
ing sources. Therefore, the amount of new source expansion will not be
large.
*The analysis assumes that the NSPS costs incurred for a major
modification to existing sources would not be greater than the NSPS costs
for new sources.
**The Pharmaceutical Industry, March 1979, The Morton Research
Corporation.
***This Analysis is based on announcements appearing in Drug and
Cosmetic Industry, from April 1981 through June 1982.
6-2
-------
It is extremely difficult to estimate the total cost of compliance for
NSPS based on the available data. Assuming that approximately one-half of
the announced new construction (some already on-line) qualifies for MSPS,
then the annualized cost of compliance will be approximately $12 million.
PSNS
Since the Pretreatment Standards for New Sources for cyanide are the
same as those for existing sources, there ara no incremental costs.
6-3
-------
Section 7
Regulatory Flexibility Analysis
Under the Regulatory Flexibility Act of 1980, the EPA and other
regulatory agenices are required to consider the effects of proposed
regulations on small companies. This section reviews the potential
small business impacts of the Proposed Regulations on the pharmaceutical
industry.
Definition of a Small Firm
The Act relies on the Small Business Administration (SBA) for guidance
in defining a small firm. The Small Business Act, section three, defines
a small business as:
"...a small business concern shall be deemed to be one which is
independently owned and operated and which is not dominant in its
field of operation. In addition to the foregoing criteria, the
Administration (of the SBA) , in making a detailed definition Jiay
use these criteria, among others: Number of employees and dollar
volume of business."
In addition, the SBA published specific employee based guidelines for
various business activities including manufacturing. For companies classi-
fied in SIC 2834, the SBA defined a small firm as one with not more than
750 employees.* Companies classified in SICs 2831 and 2833 with not more
than 250 employees are considered small. For the purposes of this analy-
sis, even 250 employees may be large, given that the Regulatory Flexibility
Act is concerned with firms with limited resources and avoiding regulatory
barriers to entry into an industry.
As described in Section 3, the pharmaceutical industry is character-
ized by a large number of small firms, most of which own one facility, and
a few number of large firms which each own several facilities. The 308
Survey covered 464 plants owned by 243 firms. Arranging the firms by
number of employees, from smallest to largest, and then dividing the firms
into quartiles shows how dominant these large firms are in terms of number
of plants (see Table 7-1).**
*Code of Federal Regulations, Title 13, Section 122.3-10.
**For 19 firms, employment could be determined only within a range.
-------
Table 7-1. Size Distribution of Pharmaceutical Companies
Firms by Number I 1
of Employees, \ Firm Employment I Number of Plants
From Smallest* | Range I Owned by These Firms
First Quart ile
Second Quartile
Third Quartile
Fourth Quartile
3-31
32-115
116-4,801
t 4,802-402,000 (
61
63
92
248
Each Quartile is comprised of 60 or 61 firms.
In the first quartile, each firm has only one facility. In the
second, each firm has an average 1.05 plants. However, the firms in the
fourth quartile have an average 4.13 plants. Therefore, a large
percentage of the firms employ only a small percentage of the workers and
control only a small percent of the production.*
In place of setting a single definition of small business, the cost
data has been arrayed for each regulation and option, by the employment
size quartiles given above. As can be seen in Table 7-2, none of the
proposed regulations impose a cost on that quarter of firms with the
smallest employment. In addition, the number of firms bearing costs
increases as the average size of the firms increases.
BPT Regulation
The only firms which may bear treatment costs under this proposed regu-
lation are in the fourth quartile. The smallest of the firms bearing
costs has an employment level of around 15,000. Therefore, this regula-
tion has no small business impact.
BCT Regulation
No firm in the first quartile and only one plant in the second quar-
tile have treatment costs under this proposed regulation. This firm
*3ales and employment are highly correlated for this industry, see
Section 3.
7-2
-------
employs about 70 persons, while the next firm with costs is in the third
quartile and has employment in excess of 2000. Based on the analysis
presented in Section 5, the small firm may decide to close a plant in
response to this proposed regulation. The other firms bearing costs are
larger. Two are projected to close a line or shift production to another
facility as a result of the proposed regulation. The others are not
expected to alter their pharmaceutical operations. Therefore, although
small, this proposed regulation has a potential small business impact.
Another measure of the relative impact of the proposed regulation is
the average cost-to-sales ratio of firms bearing costs, for each quar-
tile. For the proposed BCT regulation, these cost-to-sales ratios are:
First Quartile 0.00
Second Quartile 0.0300
Third Quartile 0.0010
Fourth Quartile 0.0018
Based on this measure, the smallest firms bear no impact, but there is a
sizeable impact on one small firm in the second quartile.
Since there are only three firms with significant impacts and only one
of these is a small firm, there is no disproportionate burden due to this
proposed regulation.
SAT Regulation
The proposed BAT Regulation has no impacts over those of the proposed
revisions to the BPT regulation.
PSES Regulation
The proposed PSES regulation controls cyanide in the wastewater of
plants discharging to publicly owned treatment works. It imposes no costs
on firms in the lowest two quartiles. The smallest firm bearing costs has
an employment level greater than 1270. Therefore, this proposed regula-
tion has no small business impact.
The second option considered, but not proposed, controlled total toxic
volatile organics as well as cyanide. This option would have an impact on
small businesses. As shown in Table 7-2, five firms in the lowest quar-
tile and nine firms in the second quartile might bear costs under this
option. The smallest firm which might bear costs employs only about ten
workers. The average cost-to-sales ratios for firms bearing costs under
this option are:
First Quartile 0.0087
Second Quartile 0.0027
Third Quartile 0.0016
Fourth Quartile 0.0004
7-3
-------
Table 7-2. Distribution of Firms With Treatment Costs,**
by Proposed Regulations, foe Firms
Divided by Employment Size
Firms by
Number of Employees,
from Smallest
First Quartile
Second Quartile
Third Quartile
Fourth Quartile
1 !
1
1
1 3PT*
0
0
0
3
1 1
1
1
1 BCT*
0
1
3
15
!
I ;
1
1 PSES
1 Cvanide*
0
0
3
5
1 1
1 PSES i
1 Cyanide and !
1 Volatile Organics !
5
9
18
28
Sum+ of
BPT*, 3CT*
and PSES
Cyanide*
0
1
5
19
Total Number of Firms
with Treatment Costs
19
60
25
*Proposed Regulation.
**The probability factor is not applied (see Section 5). Therefore, the
worst case assumption that all plants who might have to bear costs will
have to bear costs is used here.
+ROWS do not sum because a single firm may bear costs under more than
one proposed regulation. This column presents the total number of firms
in each employment quartile which bear costs under any of the three
proposed regulations.
7-4
-------
Since this option is not being proposed, no further Regulatory Flexibility
Analysis was undertaken.
BPT, BCT, and PSES Combined
The combined impact of the proposed regulations are also examined.
There are no costs imposed on firms in the lowest quartile, and only one
firm in the second quartile bears costs. Eighteen of the twenty-four
firms which might bear costs (or 75 percent) are in the highest quartile.
The average cost-to-sales ratios for firms bearing costs under the pro-
posed regulations are:
First Quartile 0.0000
Second Quartile 0.0300
Third Quartile 0.0010
Fourth Quartile 0.0015
The combined impacts, in terms of cost-to-sales ratios, are greatest for
the second quartile. However, there is only one firm in that quartile which
bears costs (see BCT discussion above). Therefore, the small business
impacts are not extensive, but are large in one case.
7-5
-------
Section 8
Social Costs of Proposed Regulations
Total social costs of the proposed regulations can be defined as the
value of goods and services lost to society due to the use of resources in
complying with the regulation, the use of resources in implementing the
regulations, and the reduction of output in lieu of compliance. Due to
the lack of good data on the pharmaceutical industry, a complete study of
the social costs could not be conducted. This chapter presents estimates
of the social costs based on available data.
The most significant costs can be estimated by use of a static, par-
tial equilibrium framework. Conceptually, this approach is based on an
analysis of the supply and demand relationships found in the market
directly affected by the regulations. Compliance results in increased
unit costs of production, shifting the industry's supply curve upward.
The new equilibrium will result in higher prices and reduced production
levels, and the amount of change in each depends on the unit cost increase
and the relative elasticities of supply and demand. This framework pro-
vides a means of estimating production losses and net welfare losses
incurred by producers and consumers due to decreased output, as well as
compliance costs. It does not include the costs of implementing and
enforcing the regulation, nor non-static effects such as changes in pro-
ductivity and innovation levels or the costs of reallocating unemployed
resources.
The principle component of social costs is the private real-resource
cost. This is equal to the net present value of the resources used directly
in complying with the regulation. In calculating the net present value of
compliance costs, a real discount rate of 10 percent was used.* Due to the
complexity of the pharmaceutical industry and the lack of data, it was not
feasible to estimate demand and supply elasticities, and changes in output
and price for all products. Based on the estimates of small price changes
and the few plant and line closures presented in Section 5, the dead-weight
losses will be small. Exact estimates of their size were not attempted.
The same applies to adjustment costs for displaced resources. Government
regulatory cost estimates are not available at this time and could not be
included. However, they are expected to be small in relation to compliance
costs.
The Proposed Regulations may affect innovation if the costs of com-
pliance result in reductions in research and development expenditures.
Likewise, there may be some impact on productivity and market structure.
However, based on the results presented in Section 5, these impacts are
*This is in accordance with the recommendations of the Office of
Management and Budget.
-------
likely to result in minor costs. Therefore, social costs are estimated to
equal the present value of compliance costs.* The annual social costs of
the Proposed Regulations (in 1979 dollars) are as follows:
BPT: $ 370,000
BCT: $4,855,000
BAT: zero costs
PSES, Cyanide Destruction: $200,000
*Calculation assumes investment in treatment systems to occur this
year. Therefore: Annual Social Costs = .1 (Investment Cost) + (Annual
Operating and Maintenance Cost).
3-2
-------
Section 9
Limits of the Analysis
This chapter examines various problems and shortcomings in the analysis
and recommends certain cautions in applying the results. Two basic types of
problems were found: problems with the data used in the analysis and
methodological problems.
Definition, of the Industry and Sample Size
The total cost of compliance for the industry was calculated on the
basis of the sample of establishments used for the Technical 308 Survey.
This total cost may be subject to upward revision depending on the compre-
hensiveness of the sample of establishments. Compared with data provided by
the U.S. Census of Manufactures, the survey sample of 464 establishments
appears small. This sample includes 306 establishments classified in SICs
2831, 2833, and 2834 which accounted for $13.5 billion in 1979 sales. The
remaining 158 establishments in the sample totaled $6.0 billion in 1979
sales. In contrast the estimated 1979 Census figures for SICs 2831, 2833,
and 2834 report value of shipments of $18.4 billion for 1,243 establish-
ments.* Therefore compared to the Census figures, the survey sample
includes a quarter of the establishments and almost three quarters of
sales. No comparison can be made for establishments in other SICs.
Some hesitation is prudent in a literal interpretation of these figures.
First of all, there is some uncertainty as to which establishments have been
included in the U.S. Census of Manufactures figures. Although central
administrative offices and auxiliaries are not included, the Census may
include some establishments not subject to the proposed regulations.
Second, Economic Information Service (EIS), our source for sales data,
states that their establishment sales figures are consistent with the
Census' definition of value of shipments. This has not been independently
verified. A third caveat is that the 1979 Census figures are estimates and
are subject to change. Basing the analysis on the 308 sample may result in
an underestimate of the total cost of compliance. However, this is offset
by the conservative or "worse case" assumptions made throughout the analysis.
*The 1979 value of shipments was extrapolated based on the average growth
between 1975 and 1978. The number of establishments was estimated assuming
no change from 1977.
-------
In addition, the 308 sample includes most, if not all, of the large
facilities. Therefore, any underestimate of the total cost of compliance is
small.
Treatment Cost to Plant Sales Method
This method involved comparing the treatment cost to the plant sales.
The primary obstacle was to find sales estimates for the 146 direct and
indirect dischargers which were not included in the SIS pharmaceutical data
base. Various methods were examined and discarded in favor of a regression
analysis relating plant sales to plant manufacturing employment. The method
is described in detail in Appendix A of this report. However, manufacturing
employment data came from the 308 Surveys and were valid foe 1975-1976 or
1977-1978. EIS provided plant sales estimates for 1979. This casts some
doubt on the estimates yielded by the regression equations as the dependent
and independent variables do not match with regard to year. In addition,
many large pharmaceutical plants also had other product lines operating —
usually organic chemicals, pesticides, and flavor and fragrance chemicals.
The EIS sales estimates for these plants included the nonpharmaceutical
sales as well. Therefore, a number of plants had overestimated sales and
probably resulted in a shift of the predicted regression line. In addition
to this systematic bias, there is error about the predicted sales due to
random factors. Most likely this error is small compared to that introduced
by the previous two problems. Another relatively minor source of error may
be the use of an average inflation factor to inflate plant treatment costs
from 1978 to 1979 dollars.
The sensitivity analysis consisted of replacing the regression esti-
mated sales with their lower 90 percent confidence interval end points.
BCT treatment cost to sales ratios were again calculated with this lower
sales estimate. 1*3 new plants were added to the potentially impacted
group, because no additional plants had revised cost to sales ratios of
greater than 1 percent. Of the plants already identified as potentially
impacted, none had an impact ratio greater than 3.18 percent using these
more conservative sales estimates. Previously, the greatest impact ratio
equaled 2.96 percent. Thus, despite the data problems inherent in the
regression approach, the final results do not seem to be very sensitive
to differences in sales estimates. This is due to the "tight" confidence
intervals about the mean predicted responses, which are due to the large
sample size. Table 9-1 shows the changes in impact ratios estimated by
the sensitivity analysis; seven of the 12 plants identified by the screen-
ing process had estimated sales. Similar -results are expected for the
BPT and the PSES cost-to-sales ratios.
Individual Plant Assessments
The limitations of the methods used to calculate the cost-to-sales
screening ratio have been discussed above. Due to the uncertainties arising
from these limitations, the cut-off levels for the screening measure has
9-2
-------
Table 9-1
BCT Cost-to-Sales Method: Sensitivity Analysis
Based on 1 Based on Lower
Predicted 1 90 Percent Confidence
Plant Sales ! Interval Endpoint
Tier 1:
Plants with Impact B
Ratios Greater Than D
or Equal to 3 Percent . ,
Tier 2:
Plants with Impact A A
Ratios Greater Than B C
or Equal to 2 C
Percent But Less
Than 3 Percent . .
Tier 3:
Plants With Impact
Ratios Greater
Than or Equal to
1 Percent But Less
Than 2 Percent
I
D
E
F
G
H
I
J
K
L
1
E
F
G
H
I
J
K
L
been set fairly low. The cost-to-sales ratio can not be considered a
sufficient condition foe identifying impacted plants. It is a tool to
identify a set of plants which might suffer a significant impact, while not
excluding any significantly impacted plants.
If sufficient plant-specific financial information were available to
determine the actual operating costs of each plant, the output levels of the
specific items produced, the ability of the plant to expand production or
alter product mix, and the financial and production relationships among
plants owned by a single firm; then this screening procedure would not be
necessary. In its place a model of the industry could be constructed and
the relative and absolute impact of the regulation on each plant could be
estimated. Instead, similar but less specific and detailed information has
9-3
-------
been collected for each plant and its patent firm identified by the
screening measures. The actual impact on the plant has been estimated based
on the data available. However, the quality and quantity of information
regarding market/product strength and financial success vary significantly
among the plants identified. Therefore, the confidence level in certain
plant-specific estimates may be low, but the overall assessment that in
general these proposed regulations will have only a small affect remains.
9-4
-------
Appendix A
Estimation of Pharmaceutical Plant Sales
In order to estimate the economic impacts on individual pharmaceutical
plants and the industry in general, it was necessary to estimate sales for
146 of the plants. The data base was examined and regression equations
relating sales to employment were determined.
A data base of 235 pharmaceutical direct and indirect dischargers was
compiled from the data supplied by the Technical Contractor and from the
Economic Information Systems (EIS) data base. The EIS data base provided
1979 sales estimates for each plant. The Technical Contractor assigned a
code to every plant indicating which of the four major types of production
processes were carried out there. These four groups of production pro-
cesses, called production subcategories, are fermentation, biological and
natural extractions, chemical synthesis, and formulation. Employment
(number of manufacturing employees) and direct and indirect waste flow
estimates were available for almost all plants from the Technical
Contractor.
Fifteen different combinations of production subcategories were formed
and for the purposes of this analysis, these combinations were grouped
into four large sets. Group 1 consisted of all plants that used fermenta-
tion processes (subcategory A). Group 2 consisted of all plants that used
biological extraction processes (subcategory B), not including those in
Group 1. Plants using chemical synthesis (subcategory C), but not in
groups 1 and 2, were classified as Group 3, and plants that were formu-
lators only (subcategory D) were placed in Group 4. Table A-l provides a
summary of the plant characteristics of each group.
This method of grouping plants was chosen because it preserved some
distinctions between production technologies and agreed with some
important relationships in the data. For example, all but one of the
plants using fermentation processes had wasteflows larger than 1 million
gallons per day (MGD), while all other production processes had much
smaller wasteflows. Typically, plants with fermentation processes
produced more wastewater, had more employees and greater revenues than
plants that did not use fermentation. Cross-tabulations of production
subcategory versus sales, employment, and wasteflow and the summary
statistics by production subcategory demonstrated that the three types of
synthesis processes were better indicators of sales, employment and
wasteflow than the formulation processes. This was the basis for defining
Groups 2, 3 and 4.
Various regression models linking sales to employment and wasteflow
within each group were investigated. Both log-transformed and untrans-
formed data were used. Correlation analysis by group indicated that
log-transform models between sales and exployment were the most promis-
ing . Other models associating sales and wasteflow and untransformed
-------
Table A-l
Group*
1 Mean
Std. Dev.
Median
N
1 1
1 i
1 1979 !
I Sales**
i 1000 $
123648
156984
68700
21
1
I Employment
I Manufac- 1
I turing*** 1
1 Employees '
1109
1516
450
21
i Sales to 1
| Employment
[ Ratio 1
I 1,000$/ 1
1 Employee
185,9
120.9
153.0
21
1
i 1
i Direct 1
I Flow*** 1
! MGD !
2.145
2.529
1.216
6
Indirect
Flow***
MGD
.519
.354
.124
14
2 Mean
Std. Dev.
Median
N
3 Mean
Std. Dev.
Median
48966
76393
14600
54732
91389
38
281
587
65
43
210
357
60
36
470.9
631.9
177.3
43
1000.7
1910.7
295.0
36
.059
.071
.027
.151
.265
.035
.173
.496
.007
33
.216
.341
.053
20
4
• i "—•
Mean
Std. Dev.
Median
N
___———— •
42256
76712
11300
132 ,
l L_
220
479
52
130
.1
628.6
1179.6
229.7
130
_J ____
.104
.145
.030
, il l
J 1-
.024
.064
.001
79
— . — •
*Group is All plants using fermentation processes.
Group 2: All plants using biological extractions but not fermentation.
Group 3: All plants with chemical synthesis but not fermentation nor
extraction.
Group 4: All plants which are femulators only.
**Source: Economic Information Systems.
***Source: Technical Contractor; some plants have 1976 employment while
others have 1978 employment.
A-2
-------
sales and untransformed employment were clearly inferior in terms of
R-squares. The model for Group 1 was:
In(sales) » a + b*ln(employment),
while the model for the remaining groups was:
In(sales) = a •*• b*ln2 (employment) .
The regression equations had R-squares ranging from 0.42 to 0.63. However,
the differences between the observed sales and the estimated sales (back-
transformed from their logarithims) were very large - as much as 600 percent
difference. This is further evidence that small residuals between the
transformed variables do not necessarily indicate small residuals between
the back-transformed variable. Such error was unacceptable.
After examining plots of sales versus employment (and In (sales) versus
In (employment)), several extreme outliers were discovered. Typically,
these outlying plants had a very small or very large sales to employment
ratio. When these plants were removed from the regression data base, the
R-squares improved dramatically. Justification for these exclusions can be
found by considering the sales data source: the EIS data base. EIS
generally classifies a plant under one SIC code, even if many products not
found under that SIC code are produced there. Consequently the sales
estimate for that plant includes revenues from other SIC group products
and, since the employment is the number of manufacturing employees, the
sales/employment ratio can be deceptively large. Usually, the very large
plants fit this description. Also, because the sales estimates are for
1979 and the employment estimates are from the 308 Survey data, which was
done in 1976 and 1978, several sales/ employment ratios are not what would
be expected due to unknown changes in employment over the three (or one)
year period. Several plants surveyed in 1976 were scheduled to start up in
1977 and so agreement between that employment figure and the recent sales
estimate should not be expected.
All plants with sales to employment ratio less than $70,000/employee
were removed from the regression data base. This was approximately the 10
percent quantile (i.e., 10 percent of the plants had sales/employment
ratios less than 70,000) for Groups 1, 2 and 4. This figure was chosen
since it contained nearly all the outliers found on the plots. Additional
plants with excessively high or inconsistent sales/employment ratios were
removed from Groups 3 and 4. Both indirect and direct plants removed are
listed in the following table.
A-3
-------
Table A-2
Plants Removed from Regression Data Base
Groug
1
2
3
4
*
Excluded
2
4
4
14
I of Plants in
Regression Data
21
43
36
130
Old
Base
Total 24 230
5 plants out of
235 have no
employment
estimates.
The results of the regression analysis are shown in Table A-3. Two
different models were used:
sales = a + b* (employment) for Groups 1 and 3, and
In(sales) = a + b*ln2(employment) for Groups 2 and 4.
Initial analysis showed that the equations for Groups 2 and 4 were virtually
identical, so the two groups of plants were pooled and another regression
equation was calculated.
After calculating the differences between observed sales and estimate
sales for Groups 2 and 4, it was evident that the regression equation
generally underestimated sales for these groups, thereby yielding a
relatively conservative estimate of sales in regard to the forthcoming
economic impact analysis. The elasticity of sales with regard to
employment for this model ranged from 0.11 to 1.41; this indicates that
economies of scale were preserved. The equations for Groups 1 and 3, on
the other hand, have constant elasticities.
A-4
-------
Table A-3
Regression Results
(sales in 1000 $)
1
Group
1
I Jtodel
1 1 a
1 R2 1 (t) +
1 B
1 (t)
1
1 N
1 sales * a + B * employment
.95 3109.94 144.61 19
(.77) (13.94)
244 In(sales) = a + B * In (employment) .71 3.12 0.08 155
(82.91) (19.56)
sales = a + B * employment
.83 11166.32 170.50 32
(2.04) (12.25)
+ (t) - is the t-statistic for testing whether the estimated parameter
is significantly different from zero. Except for the y-intercept
estimates for Groups A and C, all parameters were significantly greater
than zero at the 99.9% confidence level. The problems with the intercept
estimates are due to clustering of data points near the origin.
A-5
-------
Appendix B
Detailed Descriptions of Product Group
The following is an elaboration of the product group discussion in
Section 3. The value of shipments for each of these product groups is
presented in Table B-l (duplicate of Table 3-12).
Preparations Affecting Neoplasms, Endocrine System and Metabolic Diseases
This group includes a fairly diverse number of pharmaceutical
products. Shipments of $900 million were recorded in 1977; which accounts
for 9.2 percent of the final products shown in Table 3-1. Value of
shipments increased 7.9 percent annually while shipments for all eleven
groups grew 9.3 percent annually.
Hormones accounted for more than 75 percent of total group shipments.
Secreted by the endocrine glands (thyroid, pituatory, gonads, and others)
and present only in minute quantities, natural hormones regulate the
body's metabolic activities. Hydrocortisone, androgens, estrogens, and
progestogens are examples of steroid hormones. Corticotropin and insulin
are nonsteroidal hormones. Hormones shipments increased slowly at 5.3
percent annually from 1972 to 1977. While ten out of the 200 most
prescribed drugs in 1980 were oral contraceptives, they grew at annual
rate of only 2.9 percent from 1972 to 1977. Topical and systemic
corticoids (used as anti-flammatory agents) accounted for 30 percent of
group shipments and show an average annual increase of 8.8 percent from
1972 to 1977. Insulin and antidiabetic agents, sex hormones (other than
progestogens and thyroid and antithyroid preparations) all had shipment
increases well below the industry average. Antineoplastic agents, used to
treat cancerous growths, grew 21.2 percent annually from 1972 to 1977.
This subgroup includes radio-isotopes for internal use and specific
antineoplastic agents.
In summary, this product group has exhibited a lower than average rate
of increase in shipments, with only antineoplastic agents showing a growth
rate well above the industry average.
Preparations Affecting Central Nervous System and Sense Organs
Value of shipments for this group accounted for 22 percent of
shipments for all product groups, the largest of all groups. Shipments
increased only 6.4 percent annually from 1972 to reach $2.231 billion in
1977. Important subgroups are internal narcotic and non-narcotic
-------
Table B-l
Pharmaceutical Final Product Class Value of Shipments
(current dollars)
Product Class
Value of Shipments ! Uniform Average
Millions of Dollars I Increase
1977 i 1972 (Percent)
Preparations affecting neoplasms, 900 615
endocrine system ana metabolic
diseases
Preparations affecting central 2231 1636
nervous system and sense organs
Preparations affecting 751 400
cardiovascular system
Preparations affecting 396 561
respiratory system
Preparations affecting digestive 1074 746
and genito-urinary systems
Preparations affecting the skin 621 344
Vitamins, nutrients and hematinics 1302 587
Preparations affecting parasitic 1285 948
and infectious diseases
7.9
6.4
13.4
9.8
7.6
12.5
17.3
6.3
Preparations for veterinary use
Blood and blood derivatives
for human use
Active and passive immunization
agents and therapeutic
counterparts
Total
354
243
126
( 9783
214
126
89
j 6266 (
10.6
14.1
7.2
9.3
Source: 1977 U.S. Census of Manufactures Report (Current Industrial
Reports figures).
3-2
-------
analgesics and antipyretics, psychotherapeutic agents, Central Nervous
System (CNS) stimulants, sedatives and hypnotics, anesthetics, and eye and
ear preparations.
Analgesics reduce awareness of pain without loss of consciousness;
antipyretics help lower body temperature. The narcotic analgesics include
morphine and its derivatives, synthetic morphine-like drugs and synthetic
moieties of morphine molecules. Shipments of narcotic analgesics were
valued at $172 million in 1977, showing an annual increase since 1972 of
13.2 percent. Nonnarcotic analgesics, which include aspirin, phenacetin,
and acetaminophen, had 1977 shipments of $746 million with an average
annual increase since 1972 of only 5.3 percent. Aspirin, aspirin
combinations and other salicylates yielded $391 million in shipments.
Aspirin alone had a shipments increase of only 1.5 percent increase from
1972 to 1977. While the narcotic analgesics are all ethical drugs, most
of the nonnarcotic are proprietary . Also included in this group are the
nonhormonal antiarthritics.
Psychotherapeutic agents include antidepressant drugs and
tranquilizers. Shipments in 1977 were $754 million, increasing annually
at 4.9 percent since 1972.
Amphetamines, a major subgroup of CTS stimulants, typically are used
to reduce fatigue or appetite (anti-obesity drugs) . Amphetamine shipments
decreased 8.4 percent annually from 1972 to 1977. Stimulants as a whole
grew at one percent annually during the same period.
Sedatives and hypnotics (sleep inducing agents) had $97 million in
1977 shipments increasing only 2.6 percent annually since 1972. This slow
growth rate is in part due to the introduction of a number of new
nonbarbiturate drugs in the late 1970s.
General and local anesthetic shipments grew 8.6 percent annually from
1972 to reach $88 million in 1977. All growth in this subgroup has been
in local and topical anesthetics.
Eye and ear preparations have seen the highest growth in shipments
(11.6 percent) after the narcotic internal analgesics. Total shipments
were valued at $103 million in 1977. Miotics, agents that cause the pupil
to contract, mydriatics, agents that dilate the pupils, and contact lens
solutions are included in this subgroup.
In summary, while the largest product group in terms of value of
shipments , it is one of the slowest growing. Only narcotic analgesics
have been growing faster than the industry average.
B-3
-------
Preparations Affecting the Cardiovascular System
This group of products had the second highest rata of shipments
increase of all eleven groups with an annual rate of increase of 13.4
percent. Total 1977 shipments were $751 million, while 1972 sales were
$400 million. This drug market appears rather promising because a number
of new drugs with far-ranging possibilities, notably calcium and beta
blockers, have entered the market in recent years.
Anticoagulants are agents that delay or counteract blood coagulation
and are used to reduce or prevent blood clot formation within blood
vessels. Shipments in 1977 were valued at $35 million, having grown 15.0
percent annually since 1972. Hypotensives help control hypertension and
its effects, particularly high blood pressure. The major hypotensives
contain rauwolfia compounds derived from an herb. Total 1977 value of
shipments for hypotensives (the largest subgroup within this group) was
$335 million, and increased at 13.7 percent annually from 1972 to 1977.
Vasodilators induce smooth and cardiac muscle relaxation and dilate
the blood vessels. Shipments in 1977 were estimated at $156 million,
having increased only 4.5 percent annually since 1972.
The last major subgroup includes vasopressors, antiarrhythmias and
antiheparin agents. Vasopressors constrict blood vessles and thus raise
blood pressure. Antiarrhythmics help slow the irregular, rapid heartbeats
knows as arrhythmias (a potentially fatal condition for those with weak or
diseased hearts). The beta and calcium blockers are perhaps the most
important new drugs in this group. Calcium blockers prevent calcium and
minerals from entering muscle tissues and thus ease the pain of angina.
Calcium blockers have fewer side effects than beta blockers, which try to
influence the hormonal system that can speed up the heart and other
organs' action in times of stress. Shipments in 1977 for this subgroup
were $201 million, with a growth rate of 25.3 percent annually, from 1972
to 1977.
In summary, this product group has been experiencing very rapid growth
in shipments, with vasopressors, antriarrhythmics and antiheparin agents
increasing the fastest.
Preparations Affecting the Respiratory System
This product group's shipments increased 9.8 percent annually from
1972 to 1977, slightly above the overall pharmaceutical industry average
of 9.3 percent. The largest subgroup—cold preparations, both ethical and
proprietary, without antitussives—grew only 7.4 percent annually. This
subgroup had $518 million in shipments in 1977 and represented 58 percent
of respiratory system product sales. The category includes nasal
decongestants, nose drops, lozenges, and antihistamines. Cold
preparations include combinations of antibiotics, nasal decongestants,
antihistamines, analgesics, and bioflavanoids. Bronchial dilators, agents
3-4
-------
that open the lungs, bronchi, and bronchial tubes making breathing easier,
and cough preparations, both narcotic (those with codeine) and
non-narcotic, had shipments increases greater than the pharmaceutical
industry average. Antihistamines are complex amines that prevent the
buildup of histamines in body tissues and are typically used for treatment
of allergenic diseases. They are also used in nasal and ophthalmic
decongestants, sleep inducers, and antipruritics (for relief of itching).
Shipments growth of antihistamines, except those in cold preparations, was
just 4.0 percent annually from 1972 to 1977 and represented only a small
portion of the $896 million of respiratory shipments.
Preparations Affecting the Digestive and Genito-Urinary Systems
This product group accounted for just over a billion dollars in value
of shipments in 1977 and represented 11 percent of the product mix.
Antacids, the largest subgroup in this category with $300 million in 1977
shipments, have experienced growth of 0.6 percent annually since 1972.
Antacids reduce excess gastric acidity by several methods:
neutralization; buffering; a combination of absorption, buffering and
partial neutralization; or ion-exchange. Sodium bicarbonate, sodium
citrate, sodium acetate, magnesium oxide, calcium carbonate, and aluminum
hydroxide gel are common active ingredients in antacids. While antacids
are proprietary drugs, roughly 65 percent of all products in this group
are ethical. Laxative shipments increased much less quickly with an
annual percentage increase of 4.3 percent. Still, they represent 15
percent of the digestive and genito-urinary shipments. For both antacids
and laxatives there is intense competition and the rising costs of
advertising will become an important factor in sales growth in the near
future. Phenolphthalein, castor oil, magnesium sulfate, milk of magnesia,
agar, methylcellulose, mineral oil, dioctyl sodium, and calcium
sulfosuccinates are all active ingredients in laxatives. Antispasmodics
and anticholinergenics are drugs that relax involuntary (smooth) muscles
and help relieve discomfort from peptic ulcers and asthma.
Diuretics, agents that promote urine excretion, are an important
growth market. In 1977, $215 million worth of diuretics were shipped,
exhibiting a growth of 9.0 percent annually since 1972. Nearly all the
major pharmaceutical manufacturers make or market one or more of these
compounds. While diuretics increase urine, sodium, and chloride
excretion, many also promote potassium excretion. Perhaps the biggest
area for sales growth is with "potassium-sparing" diuretics. A number
already exist with others slated for release soon.
The subgroup with the largest percent increase in shipments is the
contraceptive agents (not including oral contraceptives) subgroup.
Shipments increased from $30 million in 1972 to $63 million in 1977—a
rate of 17.3 percent a year. These figures include shipments for
contraceptive foams, aerosols, and jellies.
3-5
-------
Preparations Affecting the Skin
The value of shipments foe this group increased 12.5 percent annually
between 1972 and 1977 with $621 million in shipments in 1977. This rate
is above the pharmaceutical industry average of 9.3 percent for the same
period. Dermatological preparations, used for treatment of skin
disorders, represented 63 percent of group shipments and increased 15.9
percent annually. Within this subgroup, antiacne and antiseborrehic
preparations increased 22.5 percent annually in shipments. Other drugs
contained in this group are hemorrhoidal preparations and external
analgesics.
Vitamins, Nutrients and Hematinic Preparations
This group had 1977 shipments of $1.3 billion. It had the highest
growth cate in the pharmaceutical industry (17.3 percent) and accounted
for ten percent of the total product mix. Group shipments have been
increasing strongly since the 1960s; the average annual growth in
shipments from 1967 to 1977 was 13.4 percent.
Vitamins are necessary in small quantities for normal metabolism and
are most often marketed as dietary supplements. They are also used
medicinally to prevent or treat disease. Most of the vitamin production
is by chemical synthesis. Bulk vitamins are formulated either as pills or
capsules and are frequently used by the animal feed and food additive
industries. From 1972 to 1977 multivitamin shipments increased annually
at 16.9 percent. Nutrients, not including therapeutic dietary foods and
formulations, increased in shipments 40.5 percent annually over the same
period. General dietary supplements of calcium, protein and potassium and
also infant formulas, such as Similac and Enfamil, are the major products
of this subgroup.
Hospital solutions supply a patient with fluids, nutrients and
electrolytes and shipments of such products have increased 22.6 percent
annually from 1972 to 1977. More than $380 million worth of these
products were shipped in 1977. Hematinics, agents that aid blood cell and
hemoglobin formation, were the only major subgroup of products to
experience a very low rate of sales increase—3.3 percent—in this group.
Preparations Affecting Parasitic and Infectious Diseases
Included in this group are amebicides, anthelmintics, antibiotics,
tuberculostatic agents, antimalarials, sulfonamides, antifungal
preparations, antibacterials, and antiseptics. In total 1977 shipments
value this was the third largest, with $1.28 billion. Value of shipments
growth has slowed to 6.3 percent annually from 1972 through 1977. Over 70
percent of total shipments value is due to shipments of antibiotics which
grew 7.3 percent annually from 1972 to 1977.
B-6
-------
Bcoad and medium spectrum antibiotics (not including penicillin)
accounted for more than 66 percent of total antibiotics shipments; this
subgroup includes tetracycline and its derivatives, erythrocin,
cephalosporins, and chloramphenicol. Cephalosporins have seen a number of
new developments in recent years. They are substances chemically related
to penicillins but have a broader spectrum of activity and lower acute
toxicities than penicillins. Penicillin shipments grew at a slower rate
of 6.3 percent annually. Most likely shipments will continue to grow at a
slow rate as more and more pathogens become resistant to penicillin.
However/ a number of popular antibiotics are semi-synthetic penicillins;
the precursor to penicillin is produced by fermentation and then
chemically altered to increase effectiveness.
Sulfonamides, or sulfa drugs, have been gradually replaced by
antibiotics in treating bacterial infections, but shipments growth is
above the group average, 7.4 percent annually. They are used in
diuretics, hypoglycemics, and hemotherapeutics. Antibacterials and
antiseptics have shown virutally no growth from 1972 to 1977, but
represent 13 percent of value of shipments for the group in 1977.
Preparations for Veterinary Use
This group includes all health, vitamin and nutrient products
formulated for veterinary use. There were over $350 million worth of
shipments in 1977 representing approximately three percent of total
shipments for all eleven product groups. Average annual growth from 1972
to 1977 was 10.6 percent. Most of the subgroup had little or no growth,
but antibiotics shipments grew at 12.0 percent annually and hormone
shipments increased 18.6 percent annually. Together they accounted for 46
percent of group shipments.
Blood and Blood Derivatives for Human Use
Included in this group are whole human blood, blood plasma, normal
blood serum, and other blood fractions. Total shipments in 1977 were $243
million, having increased 14.1 percent annually since 1972.
Preparations for Active and Passive Immunization and Therapeutic Counterparts
Total 1977 shipments for this group were $126 million, having shown an
average annual increase of 7.2 percent since 1972. Toxoids, antigens, and
viral vaccines are used in active immunization. An active immunization agent
alerts the body's immunological defense system and causes it to form antigens
and antibodies to deal with a possible future pathogen. Passive immunization
agents, like antitoxins, help the body deal with a pathogen that has breached
the body's defenses. Antivenins, antitoxins, immune globulins, and immune
serums are agents of passive immunization.
3-7
-------
Other Products
Product types in SIC 2831 not included in the eleven groups above are
active and passive immunization agents for veterinary use and diagnostic
substances (allergenic extracts and other biologicals). Total 1977
shipments for these product groups was $570 million.
3-8
-------
Appendix C
Capital Recovery Factor
The capital recovery factor (CRF) measures the rate of return that an
investment must achieve each year in order to cover the cost of the
investment and maintain net earnings, including depreciation and taxes.
Stated another way, the capital recovery factor is the excess of revenues
over variable costs, per dollar of invested capital, needed to cover the
cost of borrowing, depreciation and net profit-related taxes, while
preserving the market value of the firm's stock.
The formula for CRF used in previous analyses was:
A(N,K ) - td
CRF = (C-l)
1 - t
N = lifetime of investment
KJ = average after-tax cost of capital
A(N,Kj) = annuity whose present value Ls 1,
given N and Kf [Kf/{l-(l+Kf) ~N)]
d » depreciation rate
t = corporate income taxes
Changes in the tax code dealing with rapid depreciation and investment tax
credits require alterations in the formula for calculating the capital
recovery factor. The revised formula is:
CRP = (C-2)
1 - t
" td-
where: c = 'S" r
where:
n = depreciation lifetime under tax code
d' = new depreciation rate
Other variables as above.
-------
The assumptions and data used to obtain values for the above variables are
described below.
Average Cost of Capital
The cost of capital, K£, is the average percentage return that
suppliers of debt and equity demand. For firms which have more than one
type of capital, Kf is calculated as the average of the after-tax costs
of debt and the costs of equity, weighted by the share of market value of
each relative to the total market value of the firm. In equation form:
*
where:
Kf » bi(l-t) + (l-b)r (C-3)
Kf * average cost of capital after taxes
i = average cost of debt
r * average cost of equity
t « corporate income tax rate
b = share of debt financing
The costs of debt and equity are measured by the current market value
of outstanding debt and stock, rather than the original costs when the
debt and equity were issued. The argument that projects should be
evaluated using the weighted average cost of capital as the discount
factor has been made elsewhere* and rests on several assumptions. Firms
are assumed to have an optimal debt/equity ratio (or at least some
preferred debt/equity ratio), to have already obtained that ratio, and to
strive to maintain it over time. In addition, it is assumed that new
projects do not alter the overall risk position of the firm. (A change in
the risk level might result in a change in the debt/equity level.)
Therefore, new projects, on average, will be financed with these same
desired fractions of debt and equity.
Cost of Debt. Since firms often have more than one debt issue, it is
necessary to calculate an average cost within a company as well as across
companies. The following information on the debts of 40 chemical
companies was obtained from Standard and Poor's Bond Guide (August 1979).**
*See, for example, J. Fred Weston and Eugene F. Brigham, Managerial
Finance (5th ed.), Dryden Press, 1978, Chapter 19.
**It is assumed that the cost of capital to pharmaceutical companies is
very close to that for chemical companies in general.
C-2
-------
1) yield to maturity
2) debt outstanding
3) closing price'
First, the total market value of each bond issue is calculated as the
bond price multiplied by the amount of debt outstanding. Second, the
average cost of debt is calculated as a weighted average of the various
values for yield to maturity, where the weights equal the ratio of the
market value of each bond issue to the total value of debt. The average
before-tax cost of debt for these companies is 9.89 percent.
Cost of Equity. A firm's cost of equity can be expressed in equation
form as:
r = -S- + g (C-4)
P
where e is the annual dividend, P is the stock price, and g the expected
growth rate of dividends.* To estimate the firms' cost of equity, the
following data were obtained from Standard and Poor's Stock Guide (August
1979) :
1) dividend yield;
2) closing price;
3) number of shares outstanding.
Information was collected for common stocks. The existence of
preferred stocks complicates the calculations substantially, since a
preferred stock is more nearly a stock-bond hybrid. Preferred stocks are
ignored except where they represent more than 10 percent of the market
value of all stocks. In those cases where preferred stocks represent a
signficiant portion of equity, the company was removed from the survey.
An estimate of the expected growth rate was obtained using data from
the USITC Organic Chemicals (1977) and the _DRI Chemical .Review. A
weighted average of annual growth rates for plastics, fibers, and
elastomers sales was obtained for the entire industry:
g = .745(.071) + .125(.Q16) + .130(.038) = .06 (C-5)
Plastics Elastomers Fibers
Depreciation
Depreciation is normally defined as the fraction of revenues set aside
each year to cover the loss in value of the capital stock. Due to recent
changes in the federal tax code, the economic life of a capital item is
*See, for example, J. Weston and E. Brigham, op.cit.
C-3
-------
now considerably longer than the depreciation life for tax purposes.
Based on earlier work the lifetime of capital stock for this industry is
assumed to be about 10 years.* The depreciation rate for most personal
property now is straight-line over five years (20 percent). These values
are used in the revised calculation of the capital recovery factor.
Tax Sate
The current federal corporate income tax rate is 20 percent on the
first $25,000 of profits, 22 percent on the next $25,000, and 46 percent
on all profits over $50,000. For this analysis, plants are assumed to be
paying an even 46 percent federal tax on all profits. A study by Lin and
Leone** indicates that state and local income taxes also are a significant
factor in pollution control investments. State corporate income tax rates
may be as high as 9.5 percent. In their study, a weighted average of 7
steel-producing states yielded an average state corporate income tax rate
of 7.55 percent. State income taxes, of course, are deductible expenses
in computing corporate income tax. A state corporate income tax rate of 3
percent is assumed here. Deducting this figure before computing the
federal income tax rate reduces the net effect of the 8 percent rate to
about 4 percent. Thus, the overall effective income tax rate is
approximately 50 percent.
Sensitivity Analysis
Table C-l presents various values for the capital recovery factor,
assuming various weighted costs of capital (Kf) and different
formulations allowing for changes in the federal tax code. Both the rapid
depreciation and the investment tax credit serve to lower the capital
recovery factor, thus reducing the return necessary to justify a given
investment.
The weighted cost of capital is estimated based on the current costs
as reflected in the current prices and yields of a sample of corporate
stocks and bonds for that industry. In August of 1979, the weighted cost
of capital for the organic chemical industry was estimated to be about 10
percent. There are two major assumptions in using this method. First
that current prices and yields accurately reflect future costs of
capital. However, interest rates have increased significantly since the
summer of 1979. Second, that the current portfolio mix will remain
*Draft Industry Description; Organic Chemical Industry, Vol. I, Meta
Systems, December 1979.
**An Loh-Lin and Bobert A. Leone, "The Iron and Steel Industry," in
Environmental Controls, (Bobert A. Leone, ed.), Lexington, HA: Lexington
Books (1976), p. 70.
C-4
-------
constant over the next several years. Given changes in tax codes, and
changes in the availability of certain sources of capital such as
industrial revenue bonds, this is unlikely. Therefore the cost of capital
is expected to be higher than 10 percent. Given the mix of financing
sources available, the weighted cost of capital for the period covered by
this study is assumed to be close to 15 percent.
Table C-l
Alternative Derivations of the Capital Recovery Factor
Variable Values
Weighted cost of .10 .15 .20 .10 .13 .15 .20
capital (K )
Life of asset (N)
A(N, Kf)
Depreciation life (n)
Depreciation rate (d)
Tax rate (t)
c
CRF(l) .226 .298 .378
CRF(2) .201 .240 .265 .335
CRF(3) .169 .202 .225 .288
where: CRF (1) is original formula (C-l in text)
CRF (2) allows for rapid depreciation but not investment tax credit
CRF{3) allows for both rapid depreciation and investment tax credit
(C-2 in text)
A single, industry-wide CRF equal to 22 percent has been used in our
analysis. For a given investment, a firm's CRF will vary with their cost of
capital and mix of financing. However, it was not possible to estimate a
separate CRF for each establishment or firm.
10
163
10
10
50
10
.199
10
.10
.50
10
.239
10
.10
.50
10
.163
5
.20
.50
.379
10
.135
5
.20
.50
.352
10
.199
5
.20
.50
.335
10
.239
5
.20
.50
.299
C-5
------- |