• AUGUST 25, 2003

Pharma outsourcing: The next big thing

What is the first thing that comes to your mind when you hear the word 'Outsourcing'? Majority of us will say Information Technology. IT has been the key growth driver for the Indian economy. This was possible primarily on account of their strategy of successfully acting as an outsourcing base for their client. But is this dream run of IT outsourcing over? While the answer to this question will entail intense deliberations, no one will dispute the fact that pharma could be the next outsourcing success story providing further strength to the Indian economy. In this report, we shall evaluate the various avenues of outsourcing available for the domestic pharma companies.

Avenues available for Indian companies:
Indian companies have an opportunity in outsourcing in the form of contract manufacturing and contract research. The following chart gives a brief overview of the various avenues available for Indian pharma companies.

Contract manufacturing:

Contract manufacturing takes place when an Indian company utilizes its manufacturing facilities to produce drugs on behalf of an MNC. Depending upon the terms of the agreement, the Indian company either receives a fixed commission for the drugs manufactured, which are subsequently sold by the other company and/or a right to sell the drug in the domestic market. The contract manufacturing agreements are not only for the manufacture of bulk drugs but also for the production of formulations. Moreover, the formulations manufactured need not only be generics. With product patents being introduced in India from 2005, Indian contract manufacturing companies are also likely to get contracts for the production of patented drugs. But why would MNC pharma companies outsource their manufacturing activities?

Why will MNC pharma companies outsource...
After an NCE receives patent, it has to undergo clinical trials and various regulatory procedures. Only after successfully completing these requirements is it allowed to enter the market and generate revenues. These clinical trials and regulations take on an average 8 - 10 years. Thus, out of the 20 years of patented life of the drug, almost half is lost. Consequently, the company is required to make the most of the remaining patented life of the drug and generate adequate revenues to not only recover the huge R&D investments but also generate profits.

Further, globally companies have realized that pharma R&D and marketing of drugs are going to be the key drivers for growth going forward. Hence, such MNC companies would want to concentrate on these two crucial growth drivers and let some other company do the manufacturing activity. Another very important benefit accruing to these MNC companies is that they are able to isolate themselves from the various problems involved with owning a manufacturing facility like labour disputes etc. Apart from the above factors, another key reason for MNCs inclination towards outsourcing is the fact that the manufacturing can be done in developing countries at an extremely low cost.

Thus, outsourcing of manufacturing activities by MNC pharma companies is not only essential but also inevitable. But why would they outsource the same to India?

Why India...
Low cost skilled labour is the greatest advantage that India has. Indian companies have been successfully reverse engineering patented drugs since the seventies and have developed excellent skills in drug manufacturing. For drugs to be sold in the US market (the largest drug market), the plant in which it is manufactured should be US FDA approved. In view of this, an increasing number of domestic pharma companies are getting their plants approved by the US FDA. This is another factor in favour of Indian companies.

Another factor working in India's favour (though not something we should be proud of) is that the environmental norms in India are not as stringent as international ones and are also not strictly enforced. This has also prompted many MNCs to choose India for manufacturing drugs for which it would have been extremely difficult to get environmental clearance in their country. With India now allowing 100% FDI investment in the pharma sector, many MNCs might also consider establishing a base in India for carrying out their manufacturing activities.

Many big Indian companies have entered the contract-manufacturing field. Ranbaxy-Eli Lilly and Lupin-Cynamid were the first major contract manufacturing agreements entered. Off late Nicholas Piramal has taken aggressive steps for becoming an outsourcing base of choice for the MNC pharma companies. An important policy adopted by the company in this regard is its decision of not making Para 4 ANDA filings. Wockhardt and Dr Reddy's have also built plants, which could be used as a contract-manufacturing base in the future.

Contract Research:

Contract research is an agreement entered into by an Indian research company with an MNC pharma company wherein the Indian company carries out drug research and testing on behalf of the MNC. Thus, the Indian company will undertake the various stages of clinical trials on the MNC drug. This would include selecting patients on whom the tests will be carried out and also evaluating the results for the same. Apart from the above, the MNC pharma company could also enter into a contract with the Indian company for the development of a New Chemical Entity (NCE). Again, why will the MNC pharma company outsource its research activity?

Here's why...
It takes roughly US$ 350 m to US$ 500 m (source: Pfizer Journal) for an NCE to go through the various stages of clinical trails and enter the market. The MNCs hence sell the drugs at a premium to recover this high expenditure. However, off late there has been increased pressure from the US government on MNC pharma companies to bring down the drug prices. Moreover, with the US government now passing regulations enabling a smooth entry of generics there is a higher threat of competition. Hence, there is a need to bring down the R&D expenditure. This is the key reason for the MNC pharma companies opting for outsourcing their research activities. Moreover, a lot of time is wasted in identifying an ideal patient mix. This has serious implications on the performance of the company as the market launch of the drug is delayed resulting in lower marketable patent life for the drug. But then again, why India?

Why India...
Like in contract manufacturing, in contract research also India has a cost advantage. There are two key reasons for India being a low cost contract research hub. Firstly, the availability of low cost and highly skilled scientists and research personnel and secondly, the availability of large number of patients with ethnic diversity at a much lower cost. Moreover, the Indian scientists have excellent molecule synthesis skills, which give them a distinct edge over their international counterparts. With pharma research becoming more and more IT oriented, India again stands to gain as it will be in a position to leverage on its strong IT base and get more contracts. And finally, the Indian companies now follow the Good Clinical Practice (GCP) guideline, the compliance of which is prescribed by the US FDA. The above factors make India an obvious first choice when MNC pharma companies consider contracting their research activities.

Thus, pharma outsourcing is a phenomenon waiting to happen which could yield high returns for the domestic pharma companies. And very rightly, most Indian companies (big and small) have identified the same and are taking steps to project themselves as the best option for outsourcing. However, the Indian companies need to understand that although lucrative, in the long run only the research based companies will survive. Thus, ideally they should utilize the funds generated by these activities to develop a good research and development infrastructure. In short, the Indian pharma companies need to take a cue from the successful IT outsourcing model (which has been recognized globally) and gradually move up the outsourcing value chain.

Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (Research Analyst) bearing Registration No. INH000000537 (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA, Canada or the European Union countries, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

Equitymaster Agora Research Private Limited (Research Analyst)
103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407