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Pharma is a challenging sector to regulate but evidence suggests foreign ownership has not added to these challenges
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First Published: Sun, Feb 17 2013. 09 17 PM IST
The trend in profitability for the top firms is similar to that for the median firm in the industry even after FDI has flown into the sector. Thus profitability and, thereby affordability, of drugs has not been adversely impacted.
The trend in profitability for the top firms is similar to that for the median firm in the industry even after FDI has flown into the sector. Thus profitability and, thereby affordability, of drugs has not been adversely impacted.
As the Union government reviews the policy for foreign direct investment (FDI) in the pharmaceutical sector, it is worth examining if allowing 100% FDI in the sector since 2001 has adversely affected the competitive landscape.
If anything, the sales and profit data from the past decade show that fears of FDI leading to the market being dominated by a few firms are unfounded.
If 100% FDI had resulted in a few firms acquiring control of the market, then the sales of the top few firms that dominate the market should increase at a rate higher than the overall growth rate of the industry. The accompanying chart shows how industry revenue and sales of firms accounting for top 25% of sales have changed since 2000—a year before the 100% FDI rule came into place. It can be seen that sales of the top firms have been increasing at the same rate as that for the overall industry. There is no evidence of increased concentration in the hands of the top 25% firms.
Furthermore, the top 10 firms put together do not even have a 50% share of the market in any year. Is this characteristic of a concentrated industry? To compare, note that in the UK in 2004, the top four firms held the following market share in the following industries—sugar: 99%, tobacco products: 99%, gas distribution: 82%, and oils and fats: 88%. These can be called concentrated industries. In comparison, the pharmaceutical industry isn’t one, prima facie.
The number of firms that make up the top 25% of market share has been four since 2001 when the FDI policy was changed. The number of firms that make up the top 50% of market share has numbered 11-12 since 2002. The fact that these numbers haven’t changed, once again, shows that the industry is not oligopolistic. As well, in any year, the bottom half of firms accounts for no more than 4% of the market share, indicating that in addition to the large firms, there are a large number of small companies in the sector, which suggests that the large firms have not driven the smaller ones into extinction.
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If the relaxation of the FDI guidelines in 2001 had an adverse effect on competition, it would have meant that top firms are capable of increasing prices, which, in turn, means their profitability would have increased. However, such price increases will lower the affordability of the medicines. So, are the top firms indeed profiteering? The accompanying chart shows that the profitability of the top 25% firms, as measured by the ratio of profit before interest and taxes to sales, has not increased over the last decade in trend. Also, the trend in profitability for the top firms is similar to that for the median firm in the industry even after FDI has flown into the sector. Thus profitability and, thereby affordability, of drugs has not been adversely impacted.
The effect of FDI policy since 2001 can also be examined using a more rigorous metric of competition to confirm the story the figures tell so far. This can be done using Herfindahl’s index, a standard measure of intensity of competition in an industry. The Herfindahl’s index is calculated by summing the market shares of each firm in the industry and subtracting the result from one. Values of the index close to zero indicate a monopoly while values close to one indicate a competitive industry. The pharmaceutical industry has been very competitive as seen in the Herfindahl’s index being very close to one over the last 10 years. In addition, the index has not varied significantly, implying that competition in the industry has not changed since the changes in FDI policy in 2001.
In sum, the data tells us the sector has not become less competitive after the increase in FDI in 2001. When we put this conclusion together with the fact that the percentage of FDI coming into pharmaceuticals has been less than 1% of FDI across all industries in recent years, it becomes clear that the government should take steps to attract FDI into this crucial sector. The rationale for increasing the FDI cap in 2001 was that best practices and processes will be introduced in India by the multinational companies and the ability of Indian employees to work across borders would increase, which would enable the transfer of advanced technology. To make sure that these objectives are realized, greenfield projects should be made more attractive than acquisitions.
Since the availability of drugs is important, the government must retain the right to ensure availability of critical drugs through compulsory licensing. Compulsory licensing allows governments to grant a non-patent holder the permission to make a drug if the company that holds the patent has failed to make it accessible at an affordable price. India has already given its first compulsory licence. In March 2012, the government allowed Natco Pharma to legally make and sell a low-cost version of a cancer drug Nexavar on the grounds that the amount charged by the German drug maker Bayer AG for a month’s dosage was too high for patients in India.
The pharmaceutical sector is a challenging sector to regulate. However, one must recognize that these challenges apply irrespective of whether the ownership is domestic or foreign. Evidence of the last decade suggests that foreign ownership has not added to these challenges.
Comments are welcome at theirview@livemint.com
Krishnamurthy Subramanian is an assistant professor at the Indian School of Business (ISB), Hyderabad and Rajkamal Vasu is a research associate at ISB.
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First Published: Sun, Feb 17 2013. 09 17 PM IST
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