Fading glory: Indian pharma industry in uncharted terrain
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Mumbai: At the turn of the millennium when the rich world was fighting the Y2K bug, India’s drug makers were busy plotting a raid.
In a market that began opening up just a decade earlier, they had learnt to make cheap copies of patented drugs. Local laws permitted such copying if it used a production method different from the patented process. These companies had also gained expertise making ingredients for multi-national drug makers.
Finally, it was time to step out. Among the first Vikings were Ranbaxy Laboratories Ltd, Dr. Reddy’s Laboratories Ltd and Cipla Ltd.
In 2001, Hyderabad-based Dr. Reddy’s hit the jackpot in US when one of its drugs—a generic version of anti-depression drug Prozac—secured exclusive marketing rights for a limited period. The outsize profits from that one launch attracted many more drug makers to the US.
Meanwhile, Yusuf Khwaja Hamied, the scientist-chairman of Mumbai-based Cipla Ltd, started offering medication for AIDS-ravaged Africa at cut-rate prices, while the drug giants sold the same drugs at over 30 times more. For millions of patients in Africa, Hamied was god. For Big Pharma, he was captain of the pirate ship.
Suddenly, the world was the playground for India’s drug makers who had stayed home until the economic liberalization of 1991 set them free. The US would quickly become the largest market for India’s large generic drug companies.
The dream run would continue for many years. Until the engines started stalling.
Then, and now
Fast forward to 2017, and it’s not a pretty sight. Even after surviving tough scrutiny to sell drugs in the US, their profits there are no longer what they used to be. Revenue and margins have been squeezed. Alarmed by news of inspections, warnings and import alerts, investors have fled the sector.
For the first time, India’s largest drug maker, Sun Pharmaceutical Industries Ltd, on 26 May said it expects a single-digit revenue decline this fiscal, shocking investors. According to an official at a Mumbai-based pharma firm, who spoke on condition of anonymity, generic oral solid drugs, which fetched 40-60% margins till about five years ago, now earn only 20-25%. For the sector, the near-term outlook is bleak.
Pharmaceutical exports to the US jumped from $0.3 billion in 2005 to $5.9 billion in 2015, according to a February report of industry lobby Indian Pharmaceutical Alliance (IPA), which cited data from the US Department of Commerce and the US Bureau of Census. However, with the generic growth tapering off, the industry is compelled to tweak its business model.
What spelled the end of the dream run for Indian pharma? Two reasons, mainly: One, prices have fallen with rising competition and distributors buying jointly in the US; two, quality issues.
The US generic drugs market expanded at a compounded annual growth rate (CAGR) of 15% in 2010-15, but is expected to slow down to 5% CAGR in 2016-20 due to the lower value of patented drugs expiring during this period, broking firm Edelweiss Securities had said in its November 2015 report.
Brokerage firm Credit Suisse said in a May report that annual price erosion in generic drugs in the US is likely to increase to 10-12% from 7-8% currently. This is because product approvals are on the rise and consolidation has enhanced the bargaining power of pharmacy chains.
In 2012, big pharmacy chains such as Walgreens, CVS Health, Express Script and Rite-Aid bought 55% of generic drugs in US, while smaller firms bought the rest. Since then, the smaller ones have tagged on to the larger ones, resulting in four large consortia that account for nearly 90% of purchasing in 2016, the report said. Recently, Express Script started participating in the Walgreens consortium, meaning there are three giant consortia with tremendous bargaining power at the negotiating table.
As new companies enter US and existing ones seek to introduce more products, competition has increased, depressing prices and making it tough to maintain market share. While there is higher competition from more Indian companies in the US, Chinese firms are also increasing their presence.
“Historically, the Chinese cornered the API (active pharmaceutical ingredients) market, but they are getting stronger in formulations. India has had language and other skills advantage in terms of ANDA filings and regulatory process, but China is gradually importing talent and they are very good at squeezing costs,” Sameer Sah, associate partner at legal firm Khaitan and Co., said.
ANDA is short for abbreviated new drug applications filed with the US Food and Drug Administration (FDA) for a generic product approval. APIs are the essential ingredients in a drug, while formulations are the final products.
According to company officials and consultants, it’s critical for pharma companies to develop complex generics, specialty products, biosimilars and innovative products, which will drive future growth and offset pricing pressures in plain vanilla generics.
“Indian companies are still focused on a low-pricing approach. However, in a changing landscape where margins are low and pricing pressure is high, companies need to diversify their product range, adopt differential strategies and focus on evolving as innovators,” said Utkarsh Palnitkar, partner and head-infrastructure, government and healthcare, and life sciences-KPMG in India. It is also crucial to resolve compliance issues and raise overall quality.
That is easier said than done, especially while maintaining margins and profits.
“The Indian generic industry is at a critical inflection point. In the next five years, it will be imperative for the industry to transition to a specialty/innovation player or a strong biosimilar organization. However, this transition is not easy because we don’t have inherent skills of building an innovative/specialty business, which is a completely different ball game,” Glenn Saldanha, chairman and managing director of Glenmark Pharmaceuticals Ltd, said.
Yet, leading Indian drug makers such as Sun Pharma, Dr. Reddy’s Laboratories, Lupin Ltd, Cipla, Glenmark Pharmaceuticals, Cadila Healthcare Ltd, Aurobindo Pharma Ltd, and Biocon Ltd have made investments to create such products (see table for research and development spends).
“In the past 4-5 years, most leading companies are talking about specialty. It has gone from being nice-to-have to must-have. All of us, I would still say, have taken smaller bites in specialty. We need to get a lot more deep,” Nilesh Gupta, managing director of Lupin, said.
The discipline required to be a specialty company is much higher than a generic company. Plus, the specialty product offerings must have a clear clinical advantage; otherwise, doctors and insurance companies may not cover it.
Specialty drugs are high-value products used to treat complex, chronic conditions such as cancer, rheumatoid arthritis and multiple sclerosis. These products may have special handling and mode of administration.
Nearly half of the medical spend in the US currently goes towards specialty therapies. Moreover, new product launches in specialty therapies have been higher than in traditional therapies, due to substantial unmet needs, Fitch Ratings said in a November 2016 report.
“Specialty margins are significantly higher and much more stable than the generic side. Typically, brand margins are 90% plus, generic margins are 50% or thereabout. So, you can see what it means for the Ebitda (Earnings before interest, taxes, depreciation and amortization). There is no reason why 30% Ebitda cannot be maintained over a period of time,” Lupin’s Gupta said.
According to a July 2016 report by JM Financial Institutional Securities Ltd, Indian companies have been slow to make investments in the complex generics and specialty drugs space, and those that have will find the investments return-dilutive in the short-to-medium term, given the complexities and long gestation period for developing and bringing these products to the market.
The product development cost for a complex generic is around $5 million, compared with $1-2 million for a simpler final dosage form, Dr. Reddy’s said in its annual report for 2015-16. Development spends on an inhalation, complex injectable or a biosimilar product is much higher.
“Different companies are at different evolution stages but all are not going to get there. It is a very tricky battle,” Sujay Shetty, pharma leader India and Asia Pacific at PricewaterhouseCoopers Pvt. Ltd (PWC), said.
Biosimilars, a similar version of innovative biologic drugs, is also a big opportunity, but Indian firms are lagging here as well.
“In the branded space now, biologic constitutes nearly 50% of drugs by value. So, I believe the next wave of growth will come from biosimilars. Indian companies are nowhere in this area. None of their biosimilar ventures have actually taken off, but this is an area we cannot miss if India is to be relevant in future,” Sriram Shrinivasan, emerging markets leader for life sciences and global generics leader at EY, said.
The global life sciences industry is gradually moving from chemical-based drugs to biologics.
The global sales contribution of biologics is expected to increase from 24% in 2015 to 27% in 2020, Palnitkar of KPMG said.
Some Indian companies are developing biopharmaceuticals such as vaccines, biosimilars, insulin and monoclonal antibodies. In the near term, the biosimilars play for most firms will be confined to emerging markets, including India. As of now, Biocon Ltd, along with partner Mylan Inc., is the only company that has succeeded in filing applications for biosimilars in the regulated markets of the US and Europe.
Biosimilars have huge potential in emerging markets and a lot of Indian companies are looking at it; but as far as regulated markets are concerned, it is going to be a game of deep pockets, Abhijeet Mukherjee, chief operating officer of Dr. Reddy’s, said. He added that investments for biosimilars are huge and, hence, Indian companies would pursue these opportunities through partnerships.
Innovator companies are expected to queer the pitch, Shetty of PWC said.
“Earlier, Big Pharma did not care if you were making generics. This has changed in recent years due to less products coming out of pipeline. Due to lower opportunities, they have come very hard on generics and in biosimlars, they are very serious; they won’t vacate the market. This means, the cost of launch and risk of launch will be tremendously high, say $50-100 million. Very few Indian generic companies can afford that,” he said.
For a generic drug maker, transforming to a specialty- and branded drug-focused company will take a minimum of three years. These years will be tough. Also, the key will be to raise quality standards to global levels as it will lead to a steady flow of revenue which can be used for innovation initiatives, consultants said.
Then there are the inspections.
In 2009, the US FDA found severe lapses at the manufacturing units of erstwhile Ranbaxy (now merged with Sun Pharma). With India accounting for 40% of US generic drug filings, FDA decided to ensure the drugs from India are of top quality. Inspections rose from 108 in 2009 to 290 in 2015. India has the highest number of US FDA-approved plants outside the US, with the total at 572 currently, compared with 433 in 2013.
Indian drug makers currently facing FDA's warning letters, observations or import alerts include Sun Pharma, Dr. Reddy’s, Lupin, Wockhardt Ltd, Ipca Laboratories Ltd and Divi’s Laboratories Ltd.
To be sure, the rise in inspections is also due to the 2012 Generic Drug User Fee Act (GDUFA) in the US, which sought to speed up generic approvals and eliminate disparity in inspections of US and foreign manufacturing facilities.
One-fifth of the FDA inspections happen in India and China currently, up from 11% in 2012, said Edelweiss Securities in a February report.
FDA has also made other changes. It has cut prior intimation time for plant inspections to as little as 24 hours from 25-30 days and inspection frequency has increased to once or even twice a year from once in two-to-three years earlier.
The regulatory overhang is likely to persist as over the next three years, US FDA will inspect the pending 190 Indian facilities, which it hasn’t audited in the past five years, Edelweiss Securities said.
“Most Indian companies are working on increasing the level of awareness and compliance to meet US FDA standards and, in the long-term, this will also become a sustainable competitive advantage,” Mukherjee of Dr. Reddy’s said.
US FDA’s norms on good manufacturing practices keep evolving and companies need to keep pace with the changes. A plant that had cleared an FDA audit earlier may be pulled up for some violation of norms in any subsequent inspection. The crucial part here is that companies should not get repeated quality lapses observations from FDA for the same plant as it indicates that remedial measures and investments in quality upgradation were inadequate.
Consultants advising companies on quality compliance say the management’s mindset should be to overhaul the entire system in order to ensure higher quality of products in the long run and not have short-term goals.
At a time when costs are rising due to higher investments in research and development (R&D) and quality compliance, bringing operational efficiency will be crucial to maintaining profitability.
Companies will try to improve the product mix with more reliance on niche products, reduce cost of production, and sell higher volumes, D.G. Shah, secretary general of IPA, said.
“We need to continue to look at cost structures and productivity to find ways of improving our performance on total delivered costs. Investing in products, segments and markets that offer relatively more price stability would be the other way (to improve operational efficiency),” a Sun Pharma spokesperson said in response to an email query.
Shrinivasan of EY said there is a lot of inefficiency in the sector. Capacity utilization and inventory management need to improve, which will help in enhancing competitive advantage of companies.
“Companies need to further bring down costs. During the good years, there are several areas where costs had increased; but because of strong growth and margins, companies could absorb it. For example, staff costs of companies have risen significantly over the years,” Rahul Guha, partner and director at The Boston Consulting Group (BCG), said.
“This downturn (in the pharma sector) gives us an opportunity to tighten up in a way we have never done in the past and improve operational efficiency,” Lupin’s Gupta said.
Pharma companies have come up with strategies to deal with the challenges and propel growth, but the key will be execution. Adoption of information technology tools will be necessary to bring operational efficiencies.
BCG’s Guha said while the US remains the biggest market, firms should evolve their model to profitably serve other regulated markets like Europe and Japan, as well as in emerging markets.
India’s pharma exports to Europe have been around $2 billion in the past five years, while exports to Japan have come down to $34 million in 2016 from $62 million in 2012, according to data from the International Trade Centre, a joint agency of the World Trade Organization and the United Nations.
As firms enter uncharted territory of specialty and innovative products, they will need to acquire capabilities they lack, which means mergers and acquisitions and collaborations will be routine, analysts said.
“Inorganic growth can help Indian pharma firms access new markets and enhance technological capabilities in developing new drugs. Collaborations in areas such as R&D, manufacturing and marketing, can also help enhance value by reducing cost and increasing efficiency,” KPMG’s Palnitkar said. PwC’s Shetty said given the current financial profiles of Indian generic drug makers, the deal size for acquisitions is unlikely to exceed $1 billion and that, too, limited to leading firms.
Until then, the pharma sector is likely to remain under pressure.
“Pharmaceutical companies can adapt to disruption through shifts in their business models and refocus on new fields of play. However, even these changes are unlikely to generate the kind of growth and revenue that shareholders demand,” Palnitkar said.
The market has got used to rapid growth but now investors will have to take a longer-term view because for the next two-to-three years, the ups and downs in the industry are expected to continue.
The pillbox built by the early entrepreneurs has cracked, and a new one is yet to be built. For Indian drug makers, the unbridled optimism at the turn of the century is gone. This is a time to adapt, regroup and reinvent.