Lead Story

Under The Weather - Part 2

Even as it battles the US FDA, the industry has been caught off-guard by policy changes back home

The new regulation shifts the decision making from the doctor to the pharmacist who is clearly not as qualified. The fact that India has a large number of chemists who sell drugs despite not being qualified pharmacists also worsens the problem. Also, depending on the margins offered, pharmacists can push the drugs of companies that give them the highest margins. As a consequence, margins at the chemist level will take off significantly as they become a lot more important. “More than the companies reorienting their strategy, the government needs to frame strong ethical norms for pharmacists just as they have done for doctors,” points out Shaw

 The MNCs will be up against their nimble-footed Indian counterparts, who will be more than willing to hike margins and is likely to adapt more quickly to the changing environment. A top executive at one of the MNC companies, admits that internal policy issues prevent him from increasing marketing budgets or hike trade margins. “It is difficult for us to be flexible especially when our bosses are used to seeing more organised markets in other parts of the world. Also, not having significant manufacturing in India and depending on contract manufacturing makes it difficult to have cost controls,” he says. Take the case of Abbott, which with the intention of taking part in the India story, acquired the domestic formulation business of Piramal Healthcare for a whopping Rs.17,000 crore in 2010. The company set itself a revenue target of $2.5 billion within ten years. Seven years after the acquisition, Abbott has little over $1 billion in revenues to show for as it struggles to build on the lead that the acquisition gave them. 

Kewal Handa, director, Salus Lifecare and former MD, Pfizer, says companies will be forced to relook at their portfolio. “They will trim their sales force and could seriously scale down operations,” he predicts. The sharp drop in stent prices is an indicator of what could happen. Following the notification issued by the National Pharmaceutical Pricing Authority (NPPA), the price of a drug eluding stent was fixed at Rs.29,600 compared with range of Rs.40,000 to Rs.2 lakh. Bare metal stents are now at Rs.30,000 from a peak of Rs.75,000. Abbott, which gets 16% of its revenues from cardiovascular products, has already pulled out two of its advanced stents from India saying the prices are unviable. 

Handa maintains that it will lead to lower investments in R&D. “When an industry like pharmaceuticals, which depends so much on research, starts to get commoditised, it leaves very little space for innovation,” he says. While new product introductions have been driving growth in the domestic industry, its contribution to incremental growth has come down from around 50% in FY13 to around 30% in FY16 and uncertainty around prices will see fewer new product introductions in the coming years impacting the overall growth of the sector. 

With that comes the uncertainty of the future of the industry’s medical representatives, more commonly called MR. Historically, they have reached out to the doctors to push their company’s brands. D G Shah, Secretary General, Indian Pharmaceutical Alliance (IPA), the domestic drug lobby group, points out that the industry employs over five lakh MRs. “The industry also creates new MR jobs each year, which will also stop if quality products cannot be differentiated by their brands. Their jobs may become redundant,” he says.  Smaller companies like Mankind Pharma have around 10,000 MRs, while Cipla has in excess of 8,000, Sun Pharma and Lupin have about 7,000 each. The MNCs, with their limited portfolio and have a much smaller number. GSK has 3,000 MRs with Novartis and Pfizer each accounting for 2,000. 

J S Shinde, President, All India Organisation of Chemists and Druggists is concerned about how many can hold out in the business. “It is logical to believe that the market will contract both in terms of turnover and the number of players,” he says. Shinde, who heads the association that has seven lakh retailers and 1.5 lakh stockists, anticipates a decrease in the number of stockists and stock keeping units (SKUs) among other things as companies start to scale down.  “Once companies cut back on marketing and branding expenses, they will go easy on distribution. While volumes will increase, the overall size will definitely shrink,” maintains Shinde.

However that hasn’t deterred the government from pushing for increased usage of generic drugs. The government has been promoting generic drugs through its Pradhan Mantri Jan Aushadhi Pariyojna. But it has met with little success till now. Launched in 2008 as Jan Aushadhi, it has now been given a complete overhaul with the objective of bringing a larger part of the population under the umbrella of affordability. Srinivas Lanka, Chief Mentor, Pradhan Mantri Jan Aushadhi Pariyojna, estimates that only 40% of the people have access to medicines. “Once the other 60% come in, consumption will increase dramatically,” he says. The concept is to have small stores measuring about 120 square feet each, which will sell generic medicines at affordable prices. “By sourcing it directly from companies and adding a very small margin for the intermediaries, the generics are sold at 10% of the price,” he explains. So far, there are only 1,400 such kendras  across the country and another 24,000 are waiting for government approval. “It is very easy to go pan-India with this. We can open stores at key locations like railway platforms and government-owned retail outlets like khadi stores,” says Lanka.

Trouble from abroad
If there is increasing uncertainty in the domestic market, the US, the key hunting ground for large Indian pharma companies, has not made life any easier. Data from IPA points out that from just 72 FDA inspections took place in 2010 and it has sharply increased to 204 in 2015. For the first half of 2016, there were 101 inspections, taking it to 840 since 2010. The point of concern is that India is the country that has had the most number of FDA inspections during the said period followed by China and Germany at 593 and 381 respectively. (see: Uncle sam is watching)

According to the report, FDA has 572 establishments on its record but 189 of them have never been inspected. “Going forward, if the FDA is able to fill-in the vacancies and starts inspecting units that may never have been inspected, the Indian pharmaceutical sector may see more pain,” it predicts quite ominously.

India is the fourth largest supplier of drugs to the US accounting for 30% of its generic imports. India which exports drugs worth $5.1 billion to the US has the largest number of US FDA-approved manufacturing facilities outside the US.  The opportunity for Indian pharma in the US took off in a big way around in 2004-05. This was soon after the US decided to go the whole hog on inexpensive generics to bring down the overall cost of healthcare. 

By introducing the Generic Drug User Fee Amendment (GDUFA) in 2012, the US ensured drug approvals were faster but called for all manufacturers to adhere to the same quality standard irrespective of where they were located. This has meant plants outside the US would go through a yearly audit from what was earlier sporadic. With the USFDA later receiving more funding, inspections are a lot more frequent. “The FDA is nitpicking and not letting go even a minor slip leading one to believe it will remain that way,” thinks Bakhru. Now, the biggies like Sun Pharma, Lupin and Dr Reddy’s Laboratories are facing the heat.

Sun Pharma, the biggest of them all, has had a problem with its Halol plant for a while now. The company received a warning letter in December 2015 for the plant, which brings in 15% of its US sales and a quarter of the profits. For FY16, its US sales reported a decline of 8%. A year later, the company was again in the midst of news for violating good manufacturing practices in December 2016. This was after the completion of remediation work. The company now plans to shift the manufacturing of key products from Halol to other plants.

In March 2016, Dr Reddy’s was the recipient of 13 observations, after an inspection of its oncology formulations unit in Andhra Pradesh by the USFDA, which was preceded by three observations for its active pharmaceutical ingredient plant in Telangana. The plant had already received a warning letter but with the production of its key product launches shifted to partner sites or other plants, the delay in resolution of the observations will not impact the company’s earnings growth in the next two years. 

Lupin was next in line, when it received in April three observations for its Goa plant, for the violation of good manufacturing practices. The Goa plant has been under the FDA scanner for a couple of years now. It accounts for 30-40% of the company’s US sales and manufactures a range of finished products, among which are oral solids and injectables.  According to Murali Gavini, former Senior Assistant Country Director, USFDA India Office, inspections are a tedious affair. “The FDA should have had dedicated investigators for systems and frauds as two separate groups. Therefore, regulatory actions were taken only when there was an adverse event with the user of a drug,” he says. “Data integrity issues surfaced only from 2012/13 and once the magnitude of the problem was realised, the FDA became very anxious about the quality of drugs from India. This is what has contributed to the intensity and rigour of the data integrity inspections.” 

There is a silver lining amongst the dark clouds. Handa thinks while the FDA has lost some level of trust and  things will get tougher in the time to come. “At the same time, there is a huge opportunity since the US wants to increase the proportion of generics. A lot will come from a $34 billion market that will go off-patent in 4-5 years,” he explains. Indian companies have only made things difficult for themselves, following concerns over quality. 

According to a report by Merrill Lynch, Indian companies could garner around 30% market share in this incremental opportunity and as a result US generic sales of Indian pharma could double in the next five years. The USFDA has been highly active in India due to the greater role played by Indian generic drugs in the healthcare system.

The valuation of the Indian pharma sector has corrected nearly 50% over the last 18 months mainly on the back of increasing regulatory concerns and price erosion in the US generics market. According to the report by Merrill Lynch, over the past five years, the Indian pharma sector has traded at over 46% premium to the overall market and the premium has shrunk to less than 5% in the last one year. So the sector is trading at a significant discount to its historic multiples. Today, it trades at 17 times its one-year forward earnings. While companies such as Sun Pharma, Lupin and Dr Reddy’s have tried to resolve the concerns by USFDA on some of their plants, their generics pipeline for the US should keep the earnings momentum strong over the next two years.

For instance Lupin’s earnings is expected to grow by more than 20% on average over the next two years, Dr Reddy’s after a fall in earnings in FY17 is expected to bounce back in the next two years with earnings almost doubling during the period. Things also look promising for Sun Pharma as earnings are expected to increase by over 30% on an average over the next two years driven by new drug launches.

 According to Bakhru, in the domestic market, there is still need for some more clarity and for all pharma companies to think differently. “They will have to fine tune their cost structure. It will not make sense to spend so much on sales and promotion,” he says. “In this changing scenario, companies will need to look at high volume production and be extremely cost-competitive,” he adds.

That said, there is still need for some more clarity on how the regulations will evolve. While multinational companies are more susceptible to losing market share in some of the key brands, Indian companies seem to be better placed given their well-diversified portfolio and higher revenue growth in the US generics business.  Indian Pharma has reinvented itself many times over in the past and now it is time to do it again. Sometimes going back to the drawing board is not a bad thing.

This is the second of a two-part series. You can find the first part here.