Uncharted territories for success

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Bhavik Narsana, Partner and Minhaz Lokhandwala, Senior Associate at Khaitan & Co, give their insights on how pharma companies should strategise in 2018 to retain and maintain the growth momentum

Earlier this year, the credit ratings agency ICRA released a report stating that the growth rate of the Indian pharmaceutical industry is likely to witness a slowdown in the next three years. ICRA estimated that between the financial years 2017-18 to 2019-20, the pharma industry is projected to grow at 7-10 per cent, a significant decline from the double-digit growth they have witnessed over the last decade. Having said that, the report of expected slowdown in the pharma industry was not wholly unexpected. In 2016, performance of the pharma sector in India was amongst the worst, alongside sectors like IT, power, real estate and capital goods.

Reasons for the slow down

The decline in profit margins of the pharma industry could be attributed to various factors. Some factors are discussed below:

Price erosion in the US: The primary reason for the decline in the growth rate is the price erosion of generic drugs in the US. The US constitutes the largest importer for Indian generic drugs, accounting for nearly 40 per cent of Indian exports. The price erosion is largely due to:

(a) Increased competition from generic distributors in the US from other countries,

(b) The USFDA fast tracking approvals,

(c) Big pharma companies increasing their presence in the generic industry,

(d) The consolidation of the distributors in the US, resulting in increased bargaining power in purchasing generic drugs. It is reported that in 2016, purchases by Walgreens, CVS Health, Express Scrip and Rite-Aid accounted for nearly 90 per cent of the purchasing in the US.

Increased compliance: In the last five years, inspections of the USFDA on Indian manufacturing facilities have been on the rise. These regulatory inspections are likely to persist (and, probably increase) over the next three years, resulting in increased costs towards compliances.

Domestic developments: On the domestic front, continuing regulatory intervention, such as the move to ban fixed dose combination drugs, increased supervision on pricing of drugs, mandatory usage of generic names (instead of brand names) in doctor prescription, demonetisation, introduction of the GST regime, etc. have all contributed in the slow-down.

A two-pronged approach

The Indian pharma industry is at a critical juncture. To ensure that the recent turmoil is not a threat to the long-term prospects of pharma companies, it will be imperative for the industry to transition and adapt to the increasing challenges posed to it. The steps which may be taken by pharma companies would be two-fold – measures which can be taken on a war front basis and long-term measures.

On a war front basis

Explore new markets: It is, perhaps, an opportune time for Indian pharma companies to infiltrate into new markets. Apart from the US, other regulated markets such as Japan, Latin America and countries in Europe looking to reduce their healthcare costs could be explored.

Domestically, a huge market which is relatively untapped is the rural market in India. Especially, the future growth potential of ayurveda, siddha and other traditional medicine systems is substantial.

Innovations: Indian companies have over the years, utilised a majority of their resources and business strategies towards manufacturing of generic drugs – on a low-pricing approach. Whilst the Indian pharma industry did become a leader in generics, the negative impact was the migration of R&D out of India. So, while innovations happened abroad, Indian companies were focused on reverse engineering.

However, in a changing landscape where margins are low and pricing pressure is high, pharma companies would need to diversify their product range, adopt differential strategies and focus on evolving as innovators in specialty drugs. Specialty drugs are high-value products used to treat complex, chronic conditions such as cancer, rheumatoid arthritis and multiple sclerosis.

One form of speciality drugs which has been tipped to have a huge market opportunity in the future are biopharmaceuticals (and specially biosimilars). After the USFDA approved the first biosimilar application (Zarxio), there have been several applications filed by pharma companies as a regulatory precedent was created. However, Indian companies have been lagging on this front.

The margins in speciality drugs are significantly higher as compared to generic drugs, and needless to say, the investments required for development of a speciality drug are much more as well. Whilst Indian pharma companies have increased their R&D spend, targeted pipeline of speciality drugs, niche molecules and complex therapies, a more focused approach by these companies would now be mandated. Of course, increased costs would have an adverse impact in the short-term, but a long-term stable EBITDA should drive these companies towards specialisation.

Inorganic growth: As pharma entities enter uncharted territory of specialty and innovative products, they will need to acquire capabilities they lack, which can best be achieved through M&As. Inorganic growth can help Indian pharma companies not only access new markets but also enhance technological capabilities in developing new drugs. Collaborations in areas such as R&D, manufacturing and marketing will cutdown production costs and pave access to more efficient and updated technology.

Ensure quality upgrades: Several Indian companies have over the last few years received warning letters, observations, and import alerts from the USFDA. Indian companies have been working on increasing the level of compliance to meet USFDA standards and, in the long-term, this will also become a sustainable competitive advantage. USFDA norms on good manufacturing practices keep evolving and companies would need to keep enhancing their plants to meet the necessary compliance requirements. This would not only benefit pharma companies from a USFDA compliance perspective, but would also help these plants prepare for requirements of other heavily regulated jurisdictions.

Also, it would only be disadvantageous for companies to get observations of quality lapses from USFDA as it indicates that remedial measures and investments in quality upgradation were inadequate, which may result in loss of market value, fresh approvals getting stuck, etc.

Long-term measures

Improve operational efficiencies: As the margins of Indian pharma companies do down, an obvious way to sustain profitability would be to bring operational efficiencies. Pharma companies can consider investing in products, segments and markets that offer more price stability and where they can bring down manufacturing costs.

Adoption of information technology tools and recognising the increasing importance of analytical data will also be necessary. The increase in available data can be used by pharma companies to influence decision making across all levels.

Another measure that may be taken is the divestment of non-core business segments. Several pharma companies have monetised their non-core assets to allow them to focus on key areas of their expertise and pipeline development.

The way forward

With an increase in competition in the generics industry and regulatory challenges, Indian pharma companies have their tasks cut out. In order to protect one of the most important industries in India, the government will also need to pay an important role. Indian pharma companies will need to relook at their business models and refocus on new fields of play.

However, even these changes may not generate the kind of rapid growth and revenue that shareholders have gotten used to.

References

5 trends to watch out for in the pharma sector in 2017

http://www.moneycontrol.com/news/business/economy/5-trends-to-watch-out-forthe-pharma-sector2017-939567.html

India’s pharma sector troubles may not end for another two years; worth buying shares now http://www.zeebiz.com/companies/news-indias-pharma-sector-troubles-may-not-en-for-another-two-years-worth-buy-shares-now-17021

Fading glory: Indian pharma industry in uncharted terrain http://www.livemint.com/Industry/FsuFVKI1dNC30O4TyWeOGO/Fading-glory-Indian-pharma-industry-in-uncharted-terrain.html

Pharma Sector Makes a Strong Recovery in 2017 http://in.finance.yahoo.com/news/pharma-industry-outlook-october-2017-195907438.html

(Disclaimer: The authors are part of the Lifesciences and Healthcare team at Khaitan & Co, Mumbai. The views expressed in this article are those of the authors alone and should not be attributed to the firm or any of its clients.)