OVERVIEW OF THE INDUSTRY

The Indian pharmaceutical sector has come a long way, being almost non-existent before 1970 to a prominent provider of healthcare products, meeting almost 95 per cent of the country's pharmaceuticals needs. The Industry today is in the front rank of Indias science-based industries with wide ranging capabilities in the complex field of drug manufacture and technology. It ranks very high in the third world, in terms of technology, quality and range of medicines manufactured. From simple headache pills to sophisticated antibiotics and complex cardiac compounds, almost every type of medicine is now made indigenously. The pharmaceutical industry in India is going through a major shift in its business model in the last few years in order to get ready for a product patent regime from 2005 onwards. This shift in the model has become necessary due to the earlier process patent regime put in place since 1972 by the Government of India. This was done deliberately to promote and encourage the domestic health care industry in producing cheap and affordable drugs. As prior to this the Indian pharmaceutical sector was completely dominated by multinational companies (MNCs). These firms imported most of the bulk drugs (the active pharmaceutical ingredients) from their parent companies abroad and sold the formulations (the end products in the form of tablets and capsules, syrups etc.) at prices unaffordable for a majority of the Indian population. The Key to success in this industry is research & development. R&D is the starting of the industry value chain and is also the most important value creator. Companies that involve in R&D do so in specific areas. They chose specific therapeutic areas to target based on their strengths in the market, and the commercial potential. This led to a revision of Government of Indias (GOI) policy towards this industry in 1972 allowing Indian firms to reverse engineer the patented drugs and produce them using a different process that was not under patent. The entry of MNCs was also discouraged by restricting foreign equity to 40%. The licensing policy was also biased towards indigenous firms and firms with lesser foreign equity1. All these measures by GOI laid foundations to a strong manufacturing base for bulk drugs and formulations and accelerated the growth in the Indian Pharmaceutical Industry (IPI), which today consists of more than 20,000

players1. As a result the Indian pharmaceutical industry today not only meets the domestic requirement but has started exporting bulk drugs as well as formulations to the international market. Currently the main activities of Indian pharmaceutical industry are broadly restricted to producing (i) Bulk drugs and (ii) formulations with very few companies risking investing in primary research aimed at developing and patenting new drugs. The bulk drug business is essentially a commodity business, where as the formulation business is primarily a market driven and brand oriented business. Multinational companies which have entered the Indian market have mostly restricted themselves to formulation segment till date. The domestic pharmaceutical industry (MNCs and Domestic) meets about 90% of the countrys bulk drug requirement and almost the entire demand for formulations2. The economics of bulk drug business and that of formulation business are quite different. Since a majority of the Indian companies are producing both bulk as well as formulations, these are considered together for the purpose of the present study.

The Changing Prescription

As per WTO, from the year 2005, India granted product patent recognition to all new chemical entities (NCEs) i.e., bulk drugs developed then onwards. This introduction of product patent regime from January 2005 is leading into long-term growth for the future which mandated patent protection on both products and processes for a period of 20 years. Under this new law, India will be forced to recognize not only new patents but also any patents filed after January 1, 1995. Under changed environment, the industry is being forced to adapt its business model to recent changes in the operating environment. Indian pharmaceutical industry is mounting up the value chain. From being a pure reverse engineering industry focused on the domestic market, the industry is moving towards basic research driven, export oriented global presence, providing wide range of value added quality products and services, innovation, product life cycle management and enlarging their market reach. The old and mature categories like anti-infectives, vitamins, analgesics are de-growing while, new lifestyle categories like Cardiovascular, Central Nervous System (CNS), Anti Diabetic are expanding at double-digit growth rates.

Strategic Issues Facing The Industry

The strategic issues shaping the modern pharmaceutical industry are: Industry Consolidation: Merger activity has been intense within the industry in the last decade. Analysts believe that three firms; GlaxoSmithKline, Bristol-Myers Squibb and Merck are likely candidates to be directly involved in the next round of industry consolidation. Eli Lilly and AstraZeneca would make the best partners for GlaxoSmithKline, combining the latter's commercialization strengths with a partner's valuable portfolio and pipeline. A merger with Merck and Johnson may provide a complementary portfolio and a shortterm revenue boost, but the long term consequences of such a deal would be a cause of concern if pursued due to the monopolistic consequences such a merger could have. Science and Innovation: Over the last decade the knowledgebase of the pharmaceutical sciences has changed dramatically and continues to change at a fairly high rate. As new technologies and bodies of scientific knowledge emerge, whole new sets of opportunities and threats are being introduced. Breakthroughs in science, innovation and technology continue to create novel opportunities for new products and processes. This has increased the pace

of the industry and major players must keep up with changes else become vulnerable. Over the last decade, we have seen this happen as companies that were not very effective in research and new product development were acquired. Increased Competition: A major issue facing the industry is the intense competition and the changing face the pharmaceutical market. The industry has seen a legion of new market entrants, increased competition among key players and industry consolidation. A host of largescale mergers and acquisitions have taken place over the last two decades. Competitive advantage within the industry is being constantly redefined and to maintain their presence, key industry players are being forced to revamp their organisational structure, overcome huge barriers in R&D, clinical trials simply to ensure continuity and maintain profitability. Changing Consumer Profile: The profile of the pharmaceutical consumer has changed. Consumers are now better informed and there are expectations on the industry to show that their products deliver better health and greater economic value. Also, in previous decades governments were either the sole or major purchasers of pharmaceutical products but the current trend shows that healthcare costs are being constantly being shifted away from the government, which acted as the traditional social purchaser, over to health insurance companies and common individuals. The increasing price sensitivity of the common consumer and financial muscle of healthcare agencies and healthinsurance companies is forcing firms in the industry to cut product prices thereby reducing margins. In the future, as government shifts more healthcare costs to the end consumer, consumers will increasingly pay more for access to healthcare and medicines and this will further increase their price sensitivity. Ageing Populations: Due to ageing global populations there is external pressure on the industry to reduce the price and long-term dependence on pharmaceuticals. This, in addition to the market requirement for the industry to improve current new medicines and lower product costs is increases the pressure on industry to aggressively reduce its cost base without compromising gross spend on research and development which most firms require to maintain competitiveness. Changing Geo-political Environment: The political environment worldwide has become a major force. Due to the sociopolitical consequences of healthcare and medicines, the pharmaceutical industry is facing increasing political pressure to reduce prices and control costs. In certain geopolitical areas, particularly in developing economies, government are increasing pressure on pharmaceutical firms to act in the social interest and this is likely to intensify in the future. Examples are issues around AIDS in Africa. African government's policies are becoming increasingly stringent with regards to the conduct of pharmaceutical firms. Decreasing Consumer Influence: A unique feature of the pharmaceutical market is that the final consumer has little or no say in the choice of medicines and treatments. Medical doctors, general practitioners and pharmacists usually act as agents of the final consumer and they are largely responsible for the consumers purchasing decisions. As a result of this

pharmaceutical companies direct a sizeable proportion of their marketing efforts at these agents. With the advent of the internet, consumer enlightenment has the capacity to erode the influence of the medical agents as consumers have easier access to medical information and treatments.

Business Model and Strategies

One of the repeated mantras of pharmaceutical company strategy over the past decade has been increasing scale Companies can only afford the considerable costs of drug development and distribution by growing larger. This is well summarized in the Price Waterhouse Coopers report Analysis and Opinions on M&A Activity (Price Waterhouse Coopers, 1999). The three observed business models from this broad strategy are:

1. Blockbuster model involving the discovery and distribution of a small number of drugs that achieve substantial global sales (usually in excess of $1 billion). The success of this model depends on achieving large returns from a small number of drugs in order to pay for the high cost of the drug discovery and development process for a large number of candidates. 2. Diversification model in which a larger number of drugs are marketed to smaller niche markets. The success of this model is not dependent on sales of a small number of drugs. However, the model only works for small markets where distribution costs are low, particularly without a blockbuster to help pay for the high development costs. 3. Intermediate model with some combination of (I) and (II).Industry analysts have recognized the blockbuster model as the dominant model (Mercer Management Consulting, 2001). However interest in alternative models is growing as consideration is being given to the marketing of biotech drugs with smaller markets and higher treatment costs and the expectation of more personalized medicine. The primary strategy of the big established pharmaceutical companies has been to increase scale through mergers and acquisitions. By building scale, the latter stages of their product pipelines have at least a handful of highly prospective blockbuster drugs. Scale also offered the capacity to both fund in-house research and draw in external research through a variety of licensing arrangements and alliances. Since the number of New Chemical Entities (NCEs) at the latter stage is so small and returns are so uncertain these solutions may last a very short duration. The gaps in the pipeline, expiration of existing blockbuster patents, and the failure of the expected blockbusters are producing another round of Merger & Acquisitions. The expected growth rates by the financial markets to sustain current valuations require a significant and questionable expansion in the number of new large selling drugs. Another strategy has been for pharmaceutical companies to diversify their business activities into lower risk activities. For example, Merck went into Medco or Johnson & Johnson expanded into household health products. As Merck recently spun off its Medco unit, it is not clear that the financial markets have rewarded this strategy.