Corporate Front: Sector Study [Is The Pharma Industry in the Pink of Profits?]

Large investments in R&D and an aggressive exports strategy could help it thrive even in the new patents regime.

India's pharmaceutical industry is in dire need of radical therapy. While price controls have squeezed the industry's profitability-net margins are as low as 4.33 per cent-Indian laws-which protect processes, not products-have discouraged pharma companies from investing in R&D. Consequently, the domestic industry's expenditure on R&D is an abysmal 1.50 to 2 per cent of sales. Worse, pharma companies now have to contend with an even bigger threat. Once the Trade-Related Intellectual Property Rights (TRIPS)-which protect product patents-are enforced by 2005, the research-starved industry is in the danger of being marginalised.

The shakeout has begun. In the past 2 years alone, 6 small companies have wound up operations. And the big have become bigger to survive: 5 of the top 10 companies have increased their marketshare by gobbling up smaller players. But size does not depend on marketshare alone; it hinges on a company's ability to discover new drugs. Although the Indian pharma industry is adept at manufacturing patented drugs through alternative-even cost-efficient-processes, it is yet to develop the capabilities to formulate new drugs. After all, imitation is cheaper than invention. It takes about $300 million (nearly Rs 1,260 crore) and 7-10 years to develop a new drug while a product can be copied in 2 years at a cost of Rs 30 crore. Points out O.P. Agarwal, 52, the Director of the Council For Scientific & Industrial Research (CSIR): ''India has succeeded in process technology simply because the costs are low.''

The industry's process capabilities are well-suited for the generics, or the non-patented, market in India, which accounts for 60-80 per cent of total sales. Since both the spread and the consumption of medicines are low, the market has a lot of potential. Today, only 30 per cent of India's population relies on allopathic medicines. Adds D. Bhadury, 57, the CEO of the Rs 413.42-crore Hoechst Marion Roussel (HMR): ''With every 1 per cent rise in Gross Domestic Product, there should be a corresponding 1.40 per cent increase in healthcare expenditure.''

Despite the pin-pricks of price controls, this is a market that no company-Indian or foreign-can ignore. The market will receive its biggest growth stimulus from urbanisation: the urban population, which moved up from 18 per cent in 1960 to 26 per cent in 1992, is expected to reach 29 per cent in 2000. The rural reach will still be limited because of the shortage of doctors and the supportive infrastructure. The market penetration costs-amounting to Rs 50 per doctor call, excluding the cost of samples-and low profitability mean that rural penetration can, at best, be incremental.

The demand for drugs is expected to grow to Rs 16,000 crore by 2001. Analyse the industry's response: between 1947-48 and 1992-93, the gross fixed asset-base of the pharma industry was just over Rs 5,500 crore. Look at the scenario since: by March, 1997, the figure had gone up to over Rs 17,500 crore-an increase of 218 per cent in 4 years. The industry expects a quantum jump once the government relaxes the three-tier pricing regime, which controls bulk drugs, formulations, and overall profitability. Although companies have shifted to products outside the Drug Price Control Order to improve their margins, the impact has been negligible since the new product segments-central nervous system, cardio-vascular, and anti-cancer-are too small to accommodate a whole host of new players.

Satish Reddy

"You need to have a strong, but highly-focused drug discovery programme to survive."
Satish Reddy, CEO, Dr Reddy's Laboratories

While the government's pricing regime has depressed prices, there are 2 other factors that corporates will have to contend with in the next decade. First, intense competition-the result of a booming small sector-results in a cascading effect on prices. A transnational introduces a patented drug in the US market at, say, $10 (Rs 420). A big Indian company introduces a copy in India within a year of the US launch at, say, a tenth of the price. The price drops drastically as small Indian companies make their own copies. Taking advantage of the economies of scale, the company that introduced the drug in the Indian market may slash its prices further. When the dust settles down, there are 100 manufacturers in the fray, and the price competition is terrible.

Another factor that companies will have to contend with is medical insurance. In the absence of such a cushion, consumers will have to pay from their pockets, making the market price-sensitive. For instance, the sales of two drugs-ranitidine and ciprofloxacin-rose when prices were slashed. Agrees Raja B. Smarta, 52, a Mumbai-based consultant: ''High volumes are a function of low prices.'' This implies a high-volume, low-margin market-a phenomenon that all future strategies will have to factor in. The pharma market itself presents a strong case for free pricing; the dire need for investment in quality and R&D makes the case stronger.

Once the National Drug Authority is set up, the gap between Indian and the US regulatory standards will be reduced. In fact, the pricing authority has become more liberal than in the past; already, the number of drugs under control have been reduced from 143 to 74. The intense competition in the Indian generics market will ensure that new drugs are not overpriced by transnationals or their Indian licencees. Ibuprofen, an analgesic, is a classic example. More than 20 years old, the drugs sells along with new generation drugs: piroxycam (a generation old) and diclofenac (the latest). Only breakthrough drugs could fetch a premium. But, even here, the size of the market, the purchasing power of the consumer, and the threat of government intervention through compulsory licensing will check premia.

As 2005 approaches, the pace of transformation will hinge on the kind of players that are likely to surface. Consolidation in the industry is inevitable: there are over 26,000 players, and over 350 of them are in the organised sector. The market, thus, is highly fragmented due to a flourishing small sector-which is a major sourcing-base for the big and medium players. Until recently, before the Glaxo-Wellcome merger in 1994, no player commanded a marketshare of more than 5 per cent. Even as size is becoming important in the domestic market, the pharma business is becoming a global game of partnerships-be it manufacturing, marketing, or R&D. And the faster India becomes a link in the global value chain, the better its chances of inching upwards. Just what are the best strategic options before the industry?

D Bhadury

"With every 1 per cent rise in gross domestic product, there should be a corresponding 1.40 per cent increase in healthcare expenditure."
D Bhadury, CEO, Hoechst Marion Roussel

Any R&D gameplan has to be backed by financial muscle. Companies like the Rs 413.42-crore HMR, the Rs 810.04-crore Glaxo India, and the Rs 652.69-crore Novartis India have the comfort of parent-company R&D spends to back them. Little wonder, then, that a few Indian companies are eyeing specific segments of the drug-discovery chain. After all, years of copying patented products has developed strong reverse-engineering skills and a process knowledge-base.

Indeed, the high costs of drug discovery necessitates tie-ups with transnationals. So, basic research, which accounts for a third of the cost of drug discovery, is a real opportunity for Indian companies, given the low costs of scientific manpower in India. Explains Bhadury: ''You don't need to have every centre of excellence in-house anymore. We could collaborate in the global R&D effort.'' You can afford to be in a truncated R&D programme, either at the beginning (basic research) or at the end (clinical trials). Obviously, basic research is a better option. Clinical trials, which account for two-thirds of the cost of a new drug, are an expensive affair; they also have to conform to the strict regulatory norms of the developed markets.

Naturally, the Rs 1,323.20-crore Ranbaxy Laboratories signed an agreement with the $8.51-billion US major Eli Lilly in January, 1995, for a basic research programme in India. Although the joint venture ran into problems because of weak patent laws in the country, which prevented the American partner from sharing its research expertise, Ranbaxy, obviously, realised the benefits of an arrangement with a company that was strong in cardio-vasculars, anti-infectives, and anti-cancer drugs. Eli Lilly, in turn, was keen on sourcing low-cost basic research from India. Explains CSIR's Agarwal: ''Outsourcing is a major phenomenon the world over. But it is a fact that transnationals flock to India because of the low cost of research.''

Perhaps the best exponent of the basic research gameplan is the Rs 261.72-crore Dr Reddy's Laboratories (DRL), which has narrowed down its focus to just a few therapeutic categories: gastro-intestinal diseases, diabetes, and heart ailments. The company's research efforts are directed at developing analogue molecules, or superior versions of existing drugs. Typically, an analogue neutralises the side-effects, or improves the therapeutic efficacy of an already-patented molecule. DRL, which has synthesised more than 200 anti-diabetic compounds, takes a drug through the basic research stage, before scouting for global buyers. Recently, the $2.20-billion Danish major, Novo Nordisk, signed a $3.25-million licensing deal with DRL for an insulin-sensitiser molecule. The transnational will put the drug through clinical trials, and if the drug turns out to be a blockbuster, both partners will benefit. Points out K. Satish Reddy, 31, the CEO of DRL: ''You need to have a strong, but highly-focused drug discovery programme to survive.''

Analogue research is not the only low-cost option available for Indian companies. Novel Drug Delivery Systems (NDDS)-superior ways of administering a drug, which demand process development skills-are worth a shot. While an analogue takes 2 years and around Rs 15 crore-Rs 30 crore to create, an NDDS can be developed within 3 years at a cost of between Rs 100 crore and Rs 200 crore. An NDDS could be a helper compound (polymer used to direct the drug to the target site), a polymer implant (a small polymer wafer, a capsule, or a gel that allows slow release), or a microsphere (a fatty compound, or liposome, that encloses the drug, slackening release and lowering toxicity). The Rs 491-crore Cipla, the Rs 311.50-crore Sun Pharmaceutical, and Ranbaxy are serious about the NDDS market in the US. An NDDS can fetch you a patent if it is a new concept; if it is an improvement, it could give you market exclusivity for 3 years in the US.

Exports, where margins are as high as 15-20 per cent compared to less than 5 per cent in the domestic market, are the key to the industry's profitability. In the 1980s, the industry imported pharmaceutical substances-basically, bulk drugs-made formulations, and exported them. Now, pharmaceutical substances account for 47 per cent of the total exports of Rs 4,500 crore. But that's just a sliver of the global generics market, which is set to explode to $20 billion by 2000. Catalysing growth will be 79 products-including Glaxo-Wellcome's Cafotaxime, a cephalosporin antibiotic-whose patents expire by 2001. Points out Visalakshi Chandramouli, 28, a research analyst at Prime Broking: ''Indian companies should make real headway in developing generic drugs since our production costs are cheaper than those of US manufacturers.''

While the largest markets for generics are the US and Europe, where institutional buyers are putting cost-pressures on companies, they are also tough to crack. Manufacturing knowhow is not difficult to acquire, but meeting the norms of the US-based Food & Drug Administration (FDA) and the UK-based Medicines Control Agency (MCA) is tough. Quality has to be consistent, and manufacturing has to follow the US-certified Good Manufacturing Practices. No wonder the Rs 490.56-crore Cipla-which exports to the US and Europe-has obtained FDA and MCA clearances for 3 products. Explains Chandramouli: ''The FDA and MCA approvals would imply that the company requires no further quality checks to export its products to other developed markets.''

Although generics are a commodity business, there is a premium attached to them if one is able to get the FDA's approval. Explains Parag Mahulikar, 50, the Director of IMS India, a pharma consultancy firm: ''The FDA is like an ISO approval. It gives a qualitative push to any business strategy.'' The increasing tendency of developed markets like the US to require sellers to possess a Drug Master File (DMF)-which details the process of manufacture and the purity-profile of the product-for their product reduces the commodity nature of the business to some extent, and enables suppliers to obtain a premium over free market prices. Crucially, the buyer would prefer not to change his supplier because of the time-at least 2 years-involved in getting fresh approvals from the FDA.

Even in unbranded generics, like pharmaceutical substances, a marketing tie-up is of the essence. Each market has its unique characteristics. The biggest generics buyers in the US, for instance, are the Health Maintenance Organisations (hmos). So, you either tie up with an HMO or a pharmaceutical company that has an HMO. For instance, the Rs 336.53-crore Wockhardt, which has developed 2 generic drugs-a cardiovascular and a psychotropic-is searching for a marketing partner in both Europe and the US. Admits F.T. Khorakiwala, 56, CEO, Wockhardt: ''A licensing arrangement provides an easier, and more cost-effective, entry into global markets.''

One area that Indian companies do not have to worry about is their understanding of the domestic market. Since it does not have a large buyer like the HMO, products are primarily targeted at the physician. So, a company's marketing muscle depends on the size of its sales-force or its medical representatives. And most of them have specialised in the marketing of anti-infectives, which account for a whopping 65 per cent of the Indian market. With such a disease- and customer-profile, transnationals would prefer to place marketing tie-ups at the centre of their India gameplans. Agrees Reddy: ''It would take as many as 10 years to build a marketshare of 1 per cent in India. It is virtually impossible to start from scratch in today's circumstances.''

For transnationals, it pays to collaborate with Indian companies. The Rs 555-crore Nicholas Piramal India, for instance, has meticulously built its marketing strength to woo transnationals. With the acquisition of the Indian offshoot of the $5-billion Hoffman La Roche and a marketing tie-up with the Rs 383.87-crore Reckitt & Colman, Nicholas Piramal today has the largest reach in the country: 2,500 wholesalers, 18 carrying and forwarding agents, and a 1,600-plus field force. Points out Francis Pinto, 42, the CEO (Healthcare) of the Rs 810.10-crore Piramal Group: ''The transnationals planning to enter the Indian market just cannot ignore our marketing strengths.''

And the strategy has clicked. Today, Nicholas Piramal is the licensed marketer for transnationals like the $2-million Stryker, the $1.20-million Allergan, and the $331.56-million Scholl. Its diverse product-range includes surgical instruments, and foot-care and eye-care products. By getting into the manufacture of pharmaceutical substances, the company hopes to be a licensed manufacturer too. Explains Chopra: ''The entire growth of the Piramal Group is marketing-oriented.'' To enhance his credibility as a complete player, Nicholas Piramal has acquired HMR's R&D facility even though it may not be crucial to its marketing strategy.

The biggest boost to the Indian pharmaceutical industry will come from a new patents regime. Unless India implements stricter laws, transnationals are unlikely to transfer technology to the manufacturers of pharmaceutical substances and R&D laboratories. To become a valuable part of the value chain, India must conform to norms. For Indian companies trying to specialise in NDDS or new processes, laws are as important as they are to drug discoverers. Although the advent of trips will undoubtedly lead to a shakeout, it will also help India's pharma companies rebuild their generic strengths.