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:
                                      2-2

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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.

-------
    (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

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                                        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

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    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

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                                     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

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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

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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

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    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

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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

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    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

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    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

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                                 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

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    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

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                                 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

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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

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                                 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

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                              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.

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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

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    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

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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.

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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

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                  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

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«»
                            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

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                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

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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

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    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

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                 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

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    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

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    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

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             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

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    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

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          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

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    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

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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

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                                  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

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    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

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                                 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.

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         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

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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

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         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

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                                  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

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                                   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

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                                 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

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                                 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

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                                 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

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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

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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

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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.
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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

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    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.
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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.
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                                 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.

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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

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    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

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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

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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

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