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Pharmaceutical Sector Analysis

Submitted By: Gaurav Mittal (IIM L) Prakhar Sethi (IIM L) Aadarsh Rohira (IIM L)

Introduction
Pharmaceutical industry caters to the health care need of the society by developing, researching and distributing drugs. Over the years, the pharmaceutical industry has evolved into one of the most successful industry in the world. This industry largely depends on R & D. The costs are high and the success ratio is minimal. The industry faces a peculiar challenge to incur these high costs and then manage patents to ensure sustaining revenue. The figure below shows the value chain of a pharmaceutical industry encompassing the horizontal and vertical levels.

Rankings
1. World Total Rank Company Country Revenues(USD bi llions)
1 2 3 4 5 Johnson & Johnson United States Pfizer Roche GlaxoSmithKline Novartis United States Switzerland United Kingdom Switzerland 61,90 50,01 47,35 45,83 44,27

R&D Expenses(in millions)


6,986 7,845 9,874 CHF 4,106 $7,469

Fortune 500 Ranking


103 152 171 168 183

2. India Rank
1 2 3 Cipla Ranbaxy Dr. Reddy's Laboratories

Company

Revenue 2010(Rs crore)


4,198.96 4,162.25 3,763.72

Revenue 2010(Rs billion)


41.989 41.622 37.637

3. Biggest Drugs Sales (billion $), Drug


Atorvastatin Clopidogrel

Trade name
Lipitor

Company
Pfizer Bristol-Myers Squibb and Sanofi-

year
12 (2007) > 5.9 (2005)

Plavix

Aventis

Enoxaparin Celecoxib

Lovenox or Clexane Celebrex

Sanofi-Aventis Pfizer 2.3 (2007)

Drug Classification Drugs are classified according to the affect they have on the central nervous system (CNS):
y y y

Depressants - dampen down or depress the functioning of the CNS, eg alcohol, heroin, cannabis etc. Stimulants - stimulate or speed up the functioning of the CNS, eg nicotine, amphetamines etc. Hallucinogens - distort the way we perceive things, eg mescaline, magic mushrooms, cannabis (in high doses).

Indian Market The Indian pharmaceutical industry currently tops the chart amongst India's science -based industries with wide
ranging capabilities in the complex field of drug manufacture and technology. A highly organized sector, the Indian pharmaceutical industry is estimated to be worth $ 4.5 billion, growing at about 8 to 9 percent annually. It ranks very high amongst all the third world countries, in terms of technology, quality and the vast range of medicines that are manufactured. It ranges from simple headache pills to sophisticated antibiotics and complex cardiac compounds, almost every type of medicine is now made in the Indian pharmaceutical industry. The Indian pharmaceutical sector is highly fragmented with more than 20,000 registered units. It has expanded drastically in the last two decades. The Pharmaceutical and Chemical industry in India is an extremely fragmented market with severe price competition and government price control. The Pharmaceutical industry in India meets around 70% of the country's demand for bulk drugs, drug intermediates, pharmaceutical formulations, chemicals, tablets, capsules, orals and injectibles. There are approximately 250 large units and about 8000 Small Scale Units, which form the core of the pharmaceutical industry in India (including 5 Central Public Sector Units).

Current Scenario
Drug Development Life Cycle
Similar to the assembly lines for production, found in most of the manufacturing industries, Pharmaceutical industry has evolved with its own life cycle of product development. The most cost intensive and time consuming part of it is researching for the potential marketable chemicals and then completing trials for compliance. The next part is to get the regulatory approvals to be able to manufacture and market the drug and then finally the production and marketing of the drug. Currently the time needed for a pharma company for bringing a drug from the point of its discovery to the point of getting a regulatory approval is typically 10 long years. Apart from testing the new drug on being both safe and effective, there has been increased trend of testing the cost effectiveness of the new drug. This practice has been followed now in most of the non-US western countries. These regulatory bodies test the drug from the perspective of health gain(s) promised by the new drug in comparison to the costs to be associated with that health gain. This type of approval framework is termed as Cost-effectiveness analysis (CEA).

The large amount of time and resources required to research, perform trials and then get the required regulatory approvals are proving to be quite cumbersome for the pharmaceutical industry. The big players have the required capital to stay put on this kind of mechanism but it is proving quite detrimental to the prospects of increasing R&D activities by the smaller firms. Many smaller companies are therefore coming up in areas of producing generic drugs or specializing in only few aspects of the industry.

Mergers & Acquisitions


The pharmaceutical industry is going through the phase of consolidation since the last decade or so. Companies are trying to grow inorganically in areas other than of their expertise. We have seen mega deals involving global pharma majors like Sanofi-Aventiss USD 20.1 billion buyout of Genzyme early this year to GlaxoWellcome's USD 74 billion merger with SmithKline Beecham in the year 2000 that created GlaxoSmithKline. An important event in the Indian context has been the buyout of Ranbaxy by Daiichi-Sankyo of Japan. Ranbaxy-Daiichi-Sankyo Deal: Daiichi-Sankyo acquired controlling stake in Ranbaxy, the largest pharmaceutical company in India in the year 2008. The acquirer is the second largest drug manufacturing company of Japan and boasts of very strong credentials in drug research. On the other hand, Ranbaxy has been regularly counted among the worlds most efficient and fast growing generic drug maker. This provided the acquirer with the much needed foothold in the area of generic drugs sales and also in one of the fastest growing market like India. Daiichi Sankyo paid between USD 3.7 billion to USD 4.6 billion dollars for this deal, which proves to be a synergic fit for it.

Diversification In the view of the expiry of patents and the fear of losing revenues, pharmaceutical companies today are banking on
diversification. Animal health and diagnostics may be the first area of diversification but it is believed that consumer health and nutritionals will prove to be more immune to the economic swings. In Europe, Novartis is the best diversified company with interests in diagnostics and generics (Sandoz), followed by Sanofi-Aventis. GSK, on the other hand believes in building consumer health business through acquisition and investment in generating a differentiated clinical package for existing brands. The pure play pharmaceutical companies can benefit from successful R&D but for all others diversification is the key.

Financials
The stocks of the pharmaceutical companies have been performing exceedingly well in the last one year or so. More than half of the 99 stocks that gave more than 50% returns, listed on the Indian bourses, are pharma stocks. Even the stocks of the global majors like Pfizer have also picked up in the last 1 year and show good returns. The industry has also been enjoying very high valuations on their stocks. The industry as a whole is maintaining adequate cash reserves and has largely avoided using cash resources from the market at high interest rates. This has helped them to remain unaffected by the economic downturn and have also helped them to look for and acquire potential targets for acquisitions. But there has been growing concerns over the inability of the pharma companies in discovering and sustaining continuous development of innovative products. Drugs having market of more than USD 100 billion will be loosing patent protection for the top 50 pharma companies in the period of 2007 -2012 according to DataMonitor. The companies are yet to replace them with new innovative drugs that can generate similar or higher revenues. Even Pfizer will be loosing out on patent protection of its record breaking drug Viagra and hence making it open to competition from generic drugs.

Pharmaceutical Distribution
The distribution and retailing of drugs form an important part in the pharmaceutical space. In India, distribution and retailing has traditionally been done mostly by the unorganised sector.

Current Distribution chain in India

Earlier the manufacturer used to own most parts of the supply chain and therefore had many warehouses in each state. This later changed to the concept of having Clearing and Forwarding agents (CFA), who were given the role of stockists. The retail distribution, which is still being largely owned by the unorganised sector, is seeing a change with the advent of organised sector in retailing. This is proving quite beneficial to the pharma companies as this checks the sale of counterfeit drugs and hence improves the sales of the pharma companies. The branded drugs are also benefiting as the small retailers used to get more margins from the sale of generic drugs which is now being off-setted by this change.

Challenges
Patent Protection
The expiration of intellectual property rights is of great concern to the pharmaceutical industry. As long as drug patent lasts, the company enjoys a period of market exclusivity, in which the company is able to control the price of the drug at a level which maximizes profitability. Once the patent protection expires, the company losses its exclusivity for that drug. The drug can be manufactured by generic drug manufactures. The cost incurred by generic drug manufacturers is significantly less as they dont need to recover R&D costs. The market competition often leads to substantially lower prices for both the original brand name product and the generic forms. Lower-price generics quickly siphon off as much as 90% from the original pharmaceutical company. Takeda Pharmaceutical Co, Japan largest pharmaceutical reported that net profit fell 17% in the quarter ending March11. Prozac lost nearly 80 percent of its U.S. sales to generic versions in the first month after its patent expired. Some of the major drugs set to lose patent protection in each of the next two years are mentioned in the table:

Patent Expiring in 2011 Condition


Lipitor Zyprexa Levaquin Concerta Protonix cholesterol

Company
Pfizer

2010 U.S. Sales


$5,329,000,000 $2,496,000,000 $1,312,000,000 $929,000,000 $690,000,000

antipsychotic Eli Lily antibiotics Johnson & Johnson

ADHD/ADD Johnson & Johnson antacid Pfizer

Escalating Researchand Development costs


Based on the accounting principles, pharmaceutical industry is among one of the most profitable industries. As the R&D amount are treated as expenditures and no account is taken of the accumulated stock of knowledge. Moreover, it may cost millions of dollars to develop an innovative new drug that will cost only a few cents per dose to manufacture. The price of the drug will have no obvious connection to manufacturing cost. Most of the costs are incurred in the development of compounds which will not be approved. Further the cost depends on the type of drug being developed. New Molecular Entity (NME) drug cost more compared to incremental modification of the existing drug. A recent estimate puts the average cost of developing an innovative new drug at nearly $800 million.

This cost includes expenditures on failed projects and the value of forgone alternative investments. On average, developing NME drug takes about 12 years and a firms expenditures shows only half of the total reported cost. The continuing growth in R&D expenditures can be attributed to several other factors like such as a large number of drug projects failing at clinical trials, average number of years taken for completion of clinical trials and rising failure rate due to strict approval process followed by FDA. Advances in research technology and in the scientific opportunities facing the pharmaceutical industry have also led to an increased the research costs.

Parallel trade
Parallel Trade in pharmaceutical industry refers to the purchase of drug in low-priced country like Spain, Portugal and France to re-sell them in high-priced countries Denmark, Netherlands and the UK. A difference in the price of drugs exists because prices are fixed by the government. Such arbitrage would not have happened if prices were determined by free competitive markets. Parallel trade results in loss of revenues for pharmaceutical companies which reduce the fund available for investing in R&D. The Association of the British Pharmaceutical Industry argues that parallel trade takes 1.2bn from their revenues, money that goes to a middle man instead of being put to constructive use. Imported low-priced drugs also forces the companies to reduce prices thereby reducing the profits. Parallel trade also involves repackaging of drugs which have opened the doors to counterfeiting further decreasing the profits.

Working Capital
This is one area of concern for the pharmaceutical industry as they have traditionally not been very good in cash management because of consistently having high operating margins and ready accesses to cash. According to a recent Ernst & Young study the top 16 pharmaceutical companies have close to USD 22 Billion to USD 47 billion tied up unnecessarily in Working Capital. This adds up to around 4% to 9% of the annu sales of these companies. The al researched companies have been able to reduce their working capital to the levels of close to 82 days but the smaller players havent been doing this good. The working capital for the fortune 1000 pharmaceutical companies s still i around 170 days. Moreover, this trend of improvement in decreasing working capital has got reversed in the last 3 -4 years causing increased concerns. This freed up capital will help leverage the industry in generating more cash from their current businesses and reduce their dependence on any external financing and provide much needed flexibility in taking advantage of any opportunity that may arise.

Future Outlook
The future for the industry lies in the developing markets of India and China. These two have been among the most untapped markets for the pharmaceutical companies. The changing demographics in the world rising income levels in the developing world and ageing population in the developed world will present new set of opportunities to the pharmaceutical companies. The regulatory mechanism can get even more and more tough leading to lesser approval of new drugs. The pricing controls may increase which will lead to lesser recovery of R&D costs during the patented regime and will force the companies to restructure their costs and selling propositions. The declining rate with which companies are coming up with blockbuster drugs will increase pressure on the companies to find new methods to reduce costs and improve on existing ways. One of them can be to increase outsourcing of drug testing to specialized vendors. The Biotech companies are likely to play an ever increasing important role in the discovery of new chemicals and can led to a spree of acquisition of these companies by the pharma majors. The future for the industry looks bright as this is one of the few industries who have proved to be insular to the economic upheavals

Conclusion
The pharmaceutical industry is going through a phase of consolidation, marked by huge mergers and acquisitio ns. Different companies are trying to equip themselves with anything and everything they can find that adds to their core competencies. Large firms are sitting with huge cash at their disposal, which is giving them leverage in times of economic uncertainties and provides opportunities to cash on. The expiration of patents has been of huge concern as the pace of discovery of new blockbuster drugs has slowed down. The rising costs of research and development and the time needed to complete testing of drugs are forcing companies to look for avenues of cost reduction like outsourcing trials and thus reducing their fixed costs. The firms are coming up with new ways to improve their efficiencies in terms of production and managing their finances. The global markets are going to be much more competitive with increased regulatory constraints, which will make these firms more cost effective and flexible in their operations.

References
1. 2. 3. Parallel Trade & Supply Chain Integrity in Europe (SudeepMandhania&PinakKulkarni) Research and Development in the Pharmaceutical Industry, October 2006 by CBO How to Unlock $43 Billion in Value by Improving Working Capital Management - By Carol Cruickshank, David Hanfland, Paul Inglis and Shiv Shivaraman; A.T. Kearney 4. 5. 6. 7. 8. 9. Pharmaceutical Distribution in India India Today http://www.efpia.eu/ http://www.euractiv.com/en/health/parallel -trade-medicines/article-117528 http://en.wikipedia.org/wiki/Pharmaceutical_industry http://www.zacks.com/commentary/17173/Pharmaceutical+ Industry+Outlook http://www.duke.edu/web/soc142/team2/firms.html

10. http://www.pharmaceutical-drug-manufacturers.com/articles/pharmaceutical -market-trends-2010.html

11. http://www.prlog.org/10124036 -global-pharmaceutical-market-forecast-to-2012.html

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