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Pharma: Through Porter's eyes - Views on News from Equitymaster
 
 
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  • Aug 27, 2004

    Pharma: Through Porter's eyes

    Today's business environment is extremely competitive and in economics parlance where perfect competition exists, the profits of the firms operating in that industry will become zero in long run. However, this is not possible because, firstly there is no perfect competition and no company is a passive price taker (i.e. no company will operate where profits are zero). Secondly, they strive to create a competitive advantage to thrive in the competitive scenario. Michael Porter, considered to be one of the foremost gurus' of management, developed the famous five-force model, which influences an industry. In this article, we apply this model for the pharmaceutical industry analysis.

    Industry competition
    Pharma industry is one of the most competitive industries in the country with as many as 10,000 different players fighting for the same pie. The rivalry in the industry can be gauged from the fact that the top player in the country has only 6% market share, and the top five players together have about 18% market share. Thus, the concentration ratio for this industry is very low. High growth prospects make it attractive for new players to enter in the industry.

    Another major factor that adds to the industry rivalry is the fact that the entry barriers to pharma industry are very low. The fixed cost requirement is low but the need for working capital is high. The fixed asset turnover, which is one of the gauges of fixed cost requirements, tells us that in bigger companies this ratio is in the range of 3.5 to 4 times. For smaller companies, it would be even higher.

    Many smaller players that are focused on a particular region, have a better hang of the distribution channel, making it easier to succeed, albeit in a limited way. An important fact is that pharma is a stable market and its growth rate generally tracks the economic growth of the country with some multiple (1.2 times average in India). Though volume growth has been consistent over a period of time, value growth has not followed in tandem.

    The product differentiation is one key factor, which gives competitive advantage to the firms in any industry. However, in pharma industry product differentiation is not possible since India has followed process patents till date, with laws favouring imitators. Consequently, product differentiation is not the driver, cost competitiveness is. However, companies like Pfizer and Glaxo have created big brands in over the years, which act as product differentiation tools. This will enhance over the long term, as product patents come into play from 2005.

    Bargaining power of buyers
    The unique feature of pharma industry is that the end user of the product is different from the influencer (read Doctor). The consumer has no choice but to buy what doctor says. However, when we look at the buyer's power, we look at the influence they have on the prices of the product. In pharma industry, the buyers are scattered and they as such does not wield much power in the pricing of the products. However, government with its policies, plays an important role in regulating pricing through the NPPA (National Pharmaceutical Pricing Authority).

    Bargaining power of suppliers
    The pharma industry depends upon several organic chemicals. The chemical industry is again very competitive and fragmented. The chemicals used in the pharma industry are largely a commodity. The suppliers have very low bargaining power and the companies in the pharma industry can switch from their suppliers without incurring a very high cost.

    However, what can happen is that the supplier can go for forward integration to become a pharma company. Companies like Orchid Chemicals and Sashun Chemicals were basically chemical companies, who turned themselves into pharmaceutical companies.

    Barriers to entry
    Pharma industry is one of the most easily accessible industries for an entrepreneur in India. The capital requirement for the industry is very low, creating a regional distribution network is easy, since the point of sales is restricted in this industry in India. However, creating brand awareness and franchisee amongst doctors is the key for long-term survival. Also, quality regulations by the government may put some hindrance for establishing new manufacturing operations. Going forward, the impending new patent regime will raise the barriers to entry. But it is unlikely to discourage new entrants, as market for generics will be as huge.

    Threat of substitutes
    This is one of the great advantages of the pharma industry. Whatever happens, demand for pharma products continues and the industry thrives. One of the key reasons for high competitiveness in the industry is that as an on going concern, pharma industry seems to have an infinite future. However, in recent times, the advances made in the field of biotechnology, can prove to be a threat to the synthetic pharma industry.

    Conclusion
    This model gives a fair idea about the industry in which a company operates and the various external forces that influence it. However, it must be noted that any industry is not static in nature. It's dynamic and over a period of time the model, which have used to analyse the pharma industry may itself evolve.

    Going forward, we foresee increasing competition in the industry but the form of competition will be different. It will be between large players (with economies of scale) and it may be possible that some kind of oligopoly or cartels come into play. This is owing to the fact that the industry will move towards consolidation. The larger players in the industry will survive with their proprietary products and strong franchisee. In the Indian context, companies like Cipla, Ranbaxy and Glaxo are likely to be key players. Though consolidation within the current big names is not ruled out. Smaller fringe players, who have no differentiating strengths, are likely to either be acquired or cease to exist.

    The barriers to entry will increase going forward. The change in the patent regime, will see new proprietary products coming up, making imitation difficult. The players with huge capacity will be able to influence substantial power on the fringe players by their aggressive pricing which will create hindrance for the smaller players. Economies of scale will play an important part too. Last but not the least, in a vast country of India's size, government too will have bigger role to play.

     

     

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