Material costs, marketing and selling costs and employee expenses are the largest cost heads for players in the Indian pharmaceutical industry. Material costs account for about 50 per cent of the operating income of the industry. Marketing and selling expenses account for about 9 per cent of the operating income of the Indian pharmaceutical industry. The selling expenses of the Indian players are lower than those of the multinationals, but increased during FY1996-2001. Selling expenses in the Indian industry are considerably lower, in proportionate terms, than the same in international markets.
Indian Companies
- Alembic Limited
- Ambalal Sarabhai Limited
- Aurobindo Pharma Limited
- Cheminor Drugs Limited (merged with Dr. Reddy's Laboratories in FY2001)
- Cipla Limited
- Core Healthcare Limited
- Dr. Reddy's Laboratories Limited
- Ipca Laboratories Limited
- Kopran Limited
- Lupin Laboratories Limited (merged with Lupin Limited in FY2001)
- Lupin Limited (erstwhile Lupin Chemicals Limited)
- Lyka Laboratories Limited
- Morepen Laboratories Limited
- Nicholas Piramal India Limited
- Orchid Chemicals & Pharmaceuticals Limited
- Ranbaxy Laboratories Limited
- RPG Life Sciences Limited
- Sun Pharmaceutical Industries Limited
- Torrent Pharmaceuticals Limited
- Wockhardt Limited
MMNCs
- Aventis Pharma Limited (erstwhile Hoechst Marion Roussel Limited)
- Burroughs Wellcome (India) Limited
- German Remedies Limited
- Glaxo India Limited
- Infar (India) Limited
- Knoll Pharmaceuticals Limited
- E Merck (India) Limited
- Novartis India Limited
- Parke Davis India Limited
- Pfizer Limited
- Rhone Poulenc India Limited
- SmithKline Beecham Pharmaceuticals Limited
- Wyeth Lederle Limited
The pharmaceutical industry is characterised by low fixed asset intensity and high working capital intensity. Both Indian pharmaceutical companies and multinationals are equally prominent in this industry, with each group having a significant role to play. While the Indian companies have a presence in both bulk drugs and formulations, the multinationals are focused primarily on formulations. The economics of the bulk drugs business (essentially a commodity business) and that of the formulations business (primarily a marketing driven, brand oriented business) are quite different.
Production in the Indian pharmaceutical industry increased at a compounded annual growth rate (CAGR) of 15.9 per cent during the period FY1996-2001.
During FY2002, the Indian pharmaceutical industry recorded a healthy growth in sales, mainly on the strength of exports. A substantial decline in raw material costs and a marginal decline in employee costs absorbed the increase in other expenses and also led to a rise in the operating profit margins (OPM) of the industry. The higher OPM and the decline in interest outgo for the industry as a whole led to an increase in the net profit margin (NPM).
Material Cost
On a percentage of sales basis, the cost of raw materials is higher for a bulk drug manufacturer than for a pure formulations player. This is on account of the higher per unit realisation in the formulations segment. Further, the per unit realisation in bulk drugs tends to decline as the molecule ages. With international competition in bulk drugs increasing and the resultant volatility in prices, the margins of bulk drugs players have come under pressure. This has prompted forward integration by certain bulk drug majors, like Aurobindo Pharmaceuticals, Morepen Laboratories and Orchid.
Marketing & Selling Expenses
Marketing & selling expen-ses comprise the second largest cost head for pharmaceutical companies operating in India. This head includes the following: promotional expenses; trade discounts; freight and forwarding costs; distribution commission; and advertising costs.
As a percentage of operating income, the selling expenses of pharmaceutical companies in India increased from 8.04% in FY1996 to 9.4% in 2001. The selling costs of multinational companies in India have historically been higher than the same for Indian companies. This is because multinationals have traditionally focused on the formulations segment where the per unit selling costs are higher as compared with the bulk drugs segment.
During the period FY1996-2001, for multinationals, the selling expenses as a percentage of operating income remained volatile. A marginal increase in selling expenses was observed in FY1998-1999 but in the following year, the selling expenses declined.
The selling costs, as percentage of operating income, for bulk drug manufacturers are considerably lower than industry average (considering both bulk drug and formulation manufacturers in the ICRA sample). This is because of the commodity nature of the bulk drugs business.
Employee Cost
Employee cost was the second largest cost head for the Indian pharmaceutical industry in FY1996 and FY1997, but since FY1998, selling expenses have emerged as the second largest cost head. The industry's employee cost increased during the first half of the 1990s mainly because of the higher employment of qualified research personnel for research and development (R&D) efforts, and of direct marketing personnel. The employee cost of the industry sample declined from 9.32 per cent of the operating income in FY1996 to 8.4 per cent in FY2001.
For the Indian companies, employee cost increased during FY1996-1998 with increased employment of qualified research personnel for R&D efforts and increased employment of direct marketing personnel. However, the employee costs as a percentage of operating income declined marginally thereafter. For multinational companies, the employee cost at 11.6 per cent of the operating income (in FY2001) is substantially higher than the same for their Indian counterparts (7 per cent of operating income in FY2001). This is partially because of the higher levels of salary at some of the multinational companies. However, the employee cost for multinationals has also declined since calendar 1997 following corporate restructuring and the announcement of voluntary retirement schemes (VRS) at manufacturing facilities by many companies.
Margins
Chart 7.2 depicts the Operating Profit Margin (OPM) and Net Profit Margin (NPM) for the ICRA sample for the period FY1996 to FY2001. It shows that while the OPM, which was relatively stable during FY1996-2000, improved in FY2001, the NPM was volatile during FY1996-2001. This volatility in NPM is attributable to the increase in the share of non-operating income and extra-ordinary items in some years and the increased proportion of debt in the capital structure, which has caused a higher interest outgo.
Net Margins
In spite of the increase in operating margins, the net profit margin (NPM) for the Indian pharmaceutical industry remained volatile during the period FY1996-2001. The NPM for the industry declined during FY1996-99, but increased during FY1999-01. For the Indian players, the NPM declined from 11.9 per cent in FY1996 to 6.4 per cent in FY2000, but increased to 9.2 per cent in FY2001. For multinationals, the NPM increased from 10.3 per cent in FY1996 to 12.1 per cent in FY2001. The major reasons for the volatility in net margins are the fluctuations in non-operating income and extra-ordinary items, and the rise in interest expenses.
The contribution of non-operating income to NPM has fluctuated over the years for multinational companies. As for FY1996, FY2000 and FY2001, the increase in the non-operating and extraordinary income of multinationals during these years is attributable to profits arising out of divestments of facilities or businesses as part of restructuring.
Fixed Asset Turnover
The pharmaceutical industry is a relatively low fixed capital intensive industry. During FY1996-2001, the fixed asset turnover ratio for the ICRA sample was relatively stable. However, the ratio was higher for multinationals (in comparison with the industry average) as these players had relatively lower investments in fixed assets.
As for the Indian players, their fixed asset turnover ratio was relatively low for the period FY1996-2001 mainly because of capacity additions (both greenfield and by acquisition) by some Indian players.
Returns
Although the Indian pharmaceutical industry posted relatively stable returns during the period FY1996-2001, the returns declined during FY1996-1999 period before rising thereafter. This movement is explained by the trend in returns of the two industry segments, viz, the Indian companies and the multinationals. During FY1996-2001, the returns of the Indian companies were lower than that of multinationals. This was largely because multinationals were better users of capital than their Indian counterparts. The higher fixed asset turnover for multinationals is explained by their business model, which tends to outsource a large proportion of production from others, thus doing away with the need to invest in plant and machinery. The lower working capital requirement of multinationals is explained by the fact that their exports to sales ratio is also lower in most cases as compared with their Indian counterparts (exports necessitate maintenance of higher inventories and provision of larger credit to customers).
The debt component for some prominent Indian companies is also quite low. However, the increase in leverage for some of the Indian companies in FY1996-1998 can be attributed to the debt raised to finance expansion of facilities, and higher investments made to set up subsidiaries and joint ventures overseas.
Working Capital
The Indian pharmaceutical industry has high working capital requirements. However, over the past six years, the ratio of net working capital (NWC) to operating income (Ol) has declined for the industry as a whole from 49 per cent in FY1996 to 35.5 per cent in FY2001. Effective procurement of raw materials and management of inventories, besides a longer credit period, have enabled pharmaceutical companies reduce their working capital requirements during the past few years. However, the capital requirements for Indian players (40 per cent in FY2001) have been quite high when compared with the requirements of multinationals (25 per cent in FY2001), because of the export orientation of Indian pharmaceutical players, which requires them to maintain stock in each market they operate in. Nevertheless, the working capital requirements of multinationals increased in FY2001.
For exporters, the need to maintain stocks of finished goods causes the inventory holding period to be high. These exporters generally maintain stocks at each market they operate in. Besides, the period for transit also adds to their inventory holding figure.
In the domestic market, as the number of products in the product portfolio increases, formulators generally hold small volumes of a large number of brands. Also, the increase in the number of stock keeping units (SKUs) for products adds to the inventory holding period. This is in addition to the stocks needed to service a national distribution network that covers the country's large geographical expanse.
Formulators need to have an extensive distribution set-up, with multiple layers consisting of carrying and forwarding agents (c&f agents), wholesalers (or stockists) and retailers to make their products available in different regions. With the increase in the number of layers in the distribution set-up, the inventory held at the warehouses of the company and with the c&f agents increases. This pushes up the inventory holding periods for formulators.
- Source: ICRA