Emerging trends in the global pharmaceutical industry present unique challenges and opportunities for Indian contract manufacturing organizations (CMOs). The age of one-size-fits-all strategy will no longer work in today's changing business scenario. Now is the time for management of Indain CMOs to decide on their focus segments and build capabilities necessary to succeed in them.

The global pharmaceutical industry consists of innovators, generic companies and independent supply organizations. Innovator companies focus on developing innovative drugs and formulations that enjoy patent protection for a defined period of time, usually 20 years. Generic players focus on manufacturing versions of off-patent drugs which are similar in dosage, safety, strength, method of consumption, performance and intended use. After patent expiry of a drug, several generic versions are launched which are available for a fraction of the price of the original patented drug.

The global pharmaceutical industry is projected to grow at 6% annually from USD 700 bn in 2007 to - USD 940 bn by 2012. Thegenerics segment is expected to grow faster at 11% CAGR compared to the innovator segment at 5% CAGR during this period. This is mainly driven by governments of various developed and developing countries increasingly promoting the shift to generics in an effort to control their rising healthcare budgets. Also, globally USD 80 bn. worth of drugs are expected to go off-patent by 2010.

Changing industry dynamics
Many stereotypes are being broken in the pharmaceutical industry today due to changing realities of the marketplace. Innovator companies are increasingly acquiring generics companies (eg. Daiichi-Ranbaxy) or striking strategic alliances (eg. GSK-Aspen) in order to participate in the fast growing generics market.

Innovators and generics companies are both increasingly facing pressure on their bottom-lines. EBIT margins for most global pharmaceutical companies have been stagnating or declining over the past few years. This has forced companies to re-look at optimizing their cost structure and increased focus on outsourcing less critical activities to more cost competitive locations/ options. Manufacturing, which represents ~ 30% of the annual cost base for a typical global pharmaceutical company, offers good opportunity for significant cost savings, while simultaneously enabling it to focus all its efforts on research and marketing. Innovator companies like Pfizer, Merck and AstraZeneca have already announced intentions to contain production, costs by increasing outsourcing of manufacturing activities to emerging economies.

This is expected to lead to an increase in pharmaceutical contract manufacturing globally from USD 20 bn. in 2006 to USD40 bn.by2012.

Implications for Indian CMOs
The changes in the global pharmaceutical industry have far-reaching implications for their outsourcing partners. The generic companies spawned the first wave of contract manufacturing in India, led primarily by the need to be globally cost competitive and to protect their margins. At last count, there were over 1,500 pharmaceutical contract manufacturing firms in India, most of them focusing on basic APIs and intermediates. However, with the generics segment across the world increasingly under pressure due to increased competition, their outsourcing partners are now feeling the heat. Mushrooming of a large number of CMOs in emerging economies has also decreased their bargaining power to an extent.

Also, China is fast emerging as the destination of choice for production of basic APIs and intermediates. Government subsidies and incentives to the industry, along with the rapid pace of infrastructure development, results in their ability to get into the game and change it very quickly by focusing on building scale, there by becoming cost leaders. China, with strong basic chemistry skills, has clear advantages in products featuring wide range of applications and requiring large production volumes. However quality, reliability, environmental issues and IPR protection are some of the issues needing attention in China.

With the changing industry dynamics and increasing competition, both locally and from China, the erstwhile successful approach of most Indian CMOs of achieving economies of scale to reduce costs does not appear to be sustainable going forward.

How Indian CMOs can stay competitive
While the opportunity to service generics companies continues to offer significant potential, increasing interest in contract manufacturing by innovator companies opens up another rapidly growing segment. India, with the largest number of US FDA certified plants outside the US, maximum number of DMF filings (more than twice its closest competitor) and huge pool of highly trained technical manpower is uniquely positioned to take advantage of this opportunity.

Both innovators and generics offer different opportunities and the age of one-size-fits-all strategy is no longer valid. While the generics segment will continue to bring in the volumes, the innovator segment is likely to be more profitable. Focusing on innovators will enable current Indian CMOs to move from plain toll manufacturing to value added offerings with higher margins.

Focusing on innovators would however require basic changes in the DMA of an existing CMO. Adherence to regulations, FDA certifications and GMP will no longer suffice as a differentiating edge. Focusing on innovators would require different capabilities to be built and have a different mindset, business model and risk appetite:

Change in critical success factors
Scale and size are no longer competitive weapons. Adherence to IR world class quality standards and managing client relationships are the new determinants of success.

Shift in business model
Innovators prefer a company with a non-conflicting business model - a partner who would always assist in its operations rather than launch a competing product. A number of domestic firms offering contract manufacturing services today re-invest the revenues in developing their own compounds. This model is no longer preferred due to increased sensitivities around IP As the market matures further, these two business models will separate out completely, eg. Indian companies like Divis Laboratories and Jubilant Organosys with non-conflicting business models have been able to successfully attract global innovator companies.

The CMO should support the client in his future growth areas, eg. high potency drugs, which may require additional investment or dedicated facilities. Business development and managing client relationships is critical. Acquisitions or strategic alliances may need to be actively considered to gain access to technology or increasing global market reach, eg. Dishman Pharmaceuticals acquired Carbogen AMCIS, a Swiss company, in 2006 for its high potency manufacturing capability. This acquisition enabled the company to broaden its technological base and also gave it a European interface with the global pharmaceutical community.

Offering end-to-end services
Innovators prefer partners who can assist them across the entire value chain. This could mean extending services from drug discovery and development at one end to manufacturing of formulations and injectables at the other end. This could lead to eventually transforming itself into an end-to-end CRAMS (contract research and manufacturing) player, eg. Divis Laboratories offers services in custom chemical synthesis to several global pharmaceutical companies and enjoys one of the highest EBITDA margins in the industry.

Succeeding profitably in the new environment
The Indian contract manufacturing market is expected to grow at 38% annually from less than USD 1 bn. currently to reach USD 4.2 bn. by FY 2012. Both the innovators and generics segments offer huge potential for Indian CMOs going forward. Critical success factors for participating in the opportunity offered by each segment are different and accordingly merit serious consideration by senior management. Indian CMOs will do well if they identify their target segments, develop necessary capabilities and re-define their value proposition accordingly, failing which they may risk falling by the wayside as the industry consolidates and new entrants jump into the fray.

(Pratik Kadakia (practice head -Chemical & Energy), Jeffry Jacob and Ankur Singhai are withTata Strategic Management Group.)
--Courtesy: FICCI -- INDIACHEM 2008