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DPCO: A boon or bane? - Views on News from Equitymaster
 
 
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  • Sep 27, 2000

    DPCO: A boon or bane?

    The Drug Price Control Order (DPCO) has been the bugbear of the Indian pharma industry. Almost 40% of the value of the turnover of the industry comes under the purview of the DPCO.

    The order was promulgated in 1970 and revised thrice thereafter in 1979, 1987 and 1995. It was originally introduced to check the supernormal profits reportedly being made in the industry (those were the days of the socialists remember). The social purpose, ostensibly was to make medicines affordable to vast sections of the populace.

    The version of the order currently in force - i.e. DPCO 1995 - redefined the norms for inclusion of bulk drugs under its purview. The amended DPCO has 76 bulk drugs under price control, down from 145 in the 1987 version.

    The DPCO is administered by the National Pharmaceutical Pricing Authority (NPPA). This was set up in 1997 as the official body to administer the DPCO as the Bureau of Industrial Costs and Prices (BICP) – which was originally vested with the right to determine costs – was found unequal to the task.

    It’s not that only the bulk drug falls under the purview of the NPPA. Even the retail price of formulations (prepared from a bulk drug under price control) is also determined by the government. The rules allow the manufacturer expenses (MAPE) at the rate of 100% on the ex-factory cost.

    The DPCO, irrespective of its fallacies has however ensured that drug prices in India are among the lowest in the world. The industry however has argued, unsuccessfully though, that the DPCO is an anachronism in the era of deregulation. It has pointed out that in many cases competition among pharmaceutical companies has ensured that the prices of certain drugs under the purview of the DPCO are even lower than the prices that the DPCO has recommended!

    The more serious argument against the DPCO however is the impending implementation of the product patents regime. Domestic pharmaceutical industry has been arguing that an industry hobbled by price controls will not be able to face competition in the open economy. Such controls lower price realisations and in turn stall all hopes of a higher R & D levels.

    The NPPA argument is that the DPCO is meant to fix only the upper ceiling in prices. And the fact that increased competition may not necessarily lead to lower prices. This is partly because of the inelasticity of demand and partly to do with doctor prescriptions (i.e. if a doctor prescribes a certain drug chances are that you are going to buy only that and not belonging to any other company.)

    Companies on their part have in the past resorted to various practices to avoid getting under price control. Some of these include changing the composition of the formulation by putting in ingredients (if possible) that are not subject to price control or transferring the brand to a small–scale unit, which produces the product for a subsidiary. Pfizer for instance did change the composition of its B–complex vitamin brand Becousules (which ranks second in branded sales in the country). However, the DPCO clamped down on this move and brought the entire range of B–complex vitamins under its purview.

    The reasons for companies adopting such moves are not far to seek. A substantial percentage of revenues accrue to companies from drugs under the DPCO. This is because the DPCO covers a majority of the antibiotics, cough syrups, vitamin and mineral supplement which together comprise over 25% of the market in value terms. The bigger players in antibiotics and vitamins such as Glaxo, Ranbaxy, Cipla, Hoechst and E. Merck derive almost 60% of their revenues from products that are under price control.

    Price decontrol will better prospects for pharma cos
    Company % sales under
    price control
    E Merck 70
    Hoechst Marion Roussel 60
    Glaxo 60
    Knoll 53
    Pfizer 45
    SmithKline Beecham 33
    Novartis 20
    Ranbaxy 55
    Cipla 60
    * As at FY00

    For instance Hoechst Marion Roussel sells one billion capsules of Avil (antibiotic) at 25 paise each. Even if the price were to be increased to Rs 1 it would add Rs 750 m to Hoechst’s bottomline more than double HMR’s expected profit in the current year (Rs 370 m).

    Similar, is the case with Becousules (Pfizer’s B–complex vitamin tablets) which contributes 20% of the company’s turnover or Zevit (Smithkline Beecham’s B–complex vitamin tablets that contribute over 10% to the company’s turnover) or E Merck that derives 45% of its turnover from three vitamin combinations Polybion, Neurobion and Evion all off which are under price control.

    In practice, administering the DPCO has not been very easy either. The major problems include: availability of inadequate data on the basis of which decisions can be taken. Though the NPPA sends in its technical, costing and chemistry people to watch entire batches being produced by different manufacturers for assessment, companies often complain that the NPPA takes into account the costs of the lowest cost producer and imposes the same on the entire industry. This does not take into account the quality standards that other companies may be following.

    Another problem (as is the case with all government controls) is that decisions on price hikes (due to escalation in costs) are taken after a long period of time. Glaxo, for instance, had been asking for a price revision in the Betamethasone range (which includes Betnovate–C and Betnovate–N) for the last three years but the NPPA has allowed it to raise prices only from the current year onwards. (The allowance of higher ex–factory costs on Betamethasone formulations would add around Rs.80 million to the company’s bottomline in the current year.)

    While the pros and cons of DPCO can be debated endlessly, pharmaceutical companies have reconciled themselves to price control being in place for the next two years at least.

    HOW DOES THE DPCO WORK?

    The criterion for including a bulk drug under price control is a minimum annual turnover of Rs 40m. However, a drug with lower turnover can also be placed under price control if: (1) the turnover is in excess of Rs 10 m and (2) a single formulator has more than 90% of the market. Thus say for instance price control could apply even on sales of as low as Rs 10 m if there is only one bulk drug manufacturer who controls 90% of the market.

    Similarly, a drug (irrespective of turnover) can be exempted from price control if: (1) there are at least five manufacturers supplying it: and (2) there are at least 10 formulators, none having more than 40% of the market.

    The maximum sale price of a bulk drug is fixed by the government to yield a post-tax return of 14% on the net worth or 22% on the capital employed (at the option of the manufacturer); in the case of a new plant, an internal rate of return of 12% on long-term marginal costing may be allowed. Additionally, if production is undertaken from the basic stage, a post-tax return of 18% on the net worth or 26% on the capital employed is permitted.

    The procedure for computing retail prices for formulation is:
    Maximum Retail Price = (MC+CC+PM+PC) x (1+MAPE/100) + ED, where

    • MC is the material cost (including overages and process loses).
    • CC, PM and PC are the conversion cost, cost of packing material and packing charges respectively, computed in accordance with established procedures of costing.
    • MAPE includes all costs incurred from the ex-factory stage to retailing, including margins for the manufacture and retailer.
    • ED is the excise duty.

     

     

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