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R&D or bust! - Views on News from Equitymaster
 
 
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  • Nov 26, 1999

    R&D or bust!

    The second quarter financial year 2000 results of most pharmaceutical companies have been pretty lukewarm. That is mainly why Indian fund managers have given pharma stocks the boot, and have replaced them with more economy-related (cement, metals) stocks. Pharma stocks may have gone into comatose for the time being, but no one is willing to write off Indian pharma companies as yet.

    By any standards, the Rs 168 billion ($ 3.9 billion) Indian pharma segment has done well for itself, clocking 16 percent compounded annual growth (CAGR) over the past decade. But the market is still puny, accounting for a mere 1.1 percent of the global market, despite the country accounting for 16 percent of the global population.

    Historically, the domestic pharma market was dominated by the MNCs, who controlled close to 90 percent of the market till the 60s. That changed radically when the Indian government launched the Drug Price Control Order (DPCO) in 1963 with the objective of providing drugs to Indian masses at affordable rates. The price controls deterred MNCs from making fresh investments, and introducing new products. However, the DPCO gave the necessary fillip to domestic manufacturers to start producing mass consumption drugs like anti-tuberculosis and anti-malarial at low rates. Over the years, the DPCO has worked to the detriment of many pharma companies (local and MNCs), who at times are forced to sell products without even being able to cover their cost of production.

    The Indian Patent Act made its debut in 1970. Unlike the General Agreeement for Trade and Tariffs (GATT) agreement, the Indian Patent Act refused to acknowledge product patents and only recognised process patents. Process patents allow the manufacture of patented products by altering the process of production, such as temperature, raw materials and cycle time. Domestic manufacturers took refuge under this anomaly, and flooded the market with internationally acclaimed patented drugs with minor improvements in processes. Domestic manufacturers came to dominate the market and market share of MNCs slumped to about 40%.

    The tide turned against the domestic manufacturers in 1995, when the Indian government became a signatory to the GATT agreement. As per the agreement, India will have to recognise product patents (and not process patents) after a transition of 10 years. The fallout of this condition is that after 2005, Indian companies will no longer have the liberty to shell out patented products with minor changes in the manufacturing process. Moreover, patents will last a lot longer - 20 years, and not 7 years as was the case under the Indian Patents Act.

    So where does this leave Indian pharma companies post-2005? Quite simply, there is only one way out for Indian companies - to access new products through intensive R&D. Of course, there is always the other option of entering into marketing alliances with patent-holding MNCs. Both these options require a certain level of sales and profitability, something very few Indian companies can boast of at current levels.

    So far only a handful of Indian companies have shown the stomach and commitment for R&D. Indian R&D costs are really low (20% of those in developed countries) largely due to cheap, albeit skilled manpower. Ranbaxy, Dr Reddy's and Cipla have been in the vanguard of Indian R&D, with the former already having developed a product and has licensed the same to Bayer AG in a landmark deal.

    Post-2005, India will witness a major shakeout in the pharma sector, with increasing mergers and acquisitions. Cut-throat competition will see a lot of companies closing shop. To quote Darwin 'Only the fittest (in R&D) will survive'.

     

     

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