Intermediates and APIs have been the backbone of Indian pharmaceutical industry for the last two decades. With significant cost competitiveness, Indian companies have emerged as the preferred supplier for APIs the world over and are now ranked amongst the top three API producers in the world. The API market size was estimated at ~$6 billion in FY2010 and is expected to grow to ~$11.3 billion in FY 2015

Different business models
Companies in the API Industry in India have different business models based on different geographies that they cater to and their manufacturing capabilities (USFDA, cGMP etc.)
These business models include:

• Pure domestic market focus
• Domestic and ROW markets focus
• Domestic, ROW and Regulated markets focus
• Marketing products to both the domestic and ROW markets along with providing Contract research and manufacturing services (CRAMs)
• Large integrated players with both API and Formulation facilities

Critical business challenges faced by the sector
Working capital cycle
Indian API Industry is facing deterioration of the working capital cycle especially on the domestic debtor days and inventory periods. For most API companies, working capital cycles tend to be between 120-180 days. The banking community however continues to ignore this business aspect of the industry and refuses to fund the longer cycle

Investment in R&D
From a healthy long- term growth perspective of the Indian industry, it is imperative that the Indian API companies invest consistently in product development. Average spends on R&D by the API industry tend to be in the 2-2.5 per cent range, which is low by global standards (especially for a sector which aspires to become a global leader).

Business understanding by lenders
The working capital requirement of most API companies catering to domestic & ROW markets depends on the business plan and the geographical focus. Given these business aspects, the working capital for most of these companies tends to be between 120-180 days vis-à-vis the typical 90 day period. The lending community is uncomfortable with this business aspect and refuses to lend for such long cycles.

Any API business plan targeting the regulated markets (i.e. USA & Europe) has long gestation periods and typically requires a 5-6 year view.  Hence debt structuring needs to be planned accordingly. While larger companies have managed longer tenure products; the SME sector continues to struggle.

The Chinese challenge
China remains a dominant player in the global bulk drug industry given its large scale manufacturing capabilities, cost leadership and sufficient availability of intermediates due to strong technological capabilities in fermentation.

Given China’s strong manufacturing capabilities and growing presence in supplying APIs to the regulated markets, the ability of Indian manufacturers in developing and manufacturing niche APIs will be critical in differentiating their presence in the global stage.

Services vs. products
Most API companies are shifting focus from being only a product driven business to also providing Contract Research and Manufacturing Services (CRAMs). However this area takes time and requires sizeable capital commitments.

The incubation period in the CRAMS business is long as it takes almost 3-5 years to build relationships with innovator companies before even providing them with any services.

Consolidation trends
The API industry has seen some consolidation in the past from both global players and some domestic players. However limited activity has occurred in the last two years.  

Growth drivers Patent expiries
Drugs worth US$ 97 billion are expected to go off patent from 2011-15 in the US as compared to US$73 billion in 2006-10. The domestic API industry is poised to benefit from the impending patent expiries in the regulated markets (including many blockbuster drugs) which will lead to an increase in generic penetration; thereby providing a significant opportunity for supply of APIs to manufacturers of such generic drugs coupled with increased outsourcing of bulk drugs by multinational pharmaceutical companies.

Increased outsourcing trend
The demand for outsourced services within the global pharmaceutical industry remains intact as large pharmaceutical and biotechnology companies continue to outsource the development and manufacturing of APIs in order to focus on core priorities.

Over the past few years, pharma MNCs have begun to outsource core functions such as clinical trials and manufacturing with drug discovery being one of the recent core functions to be outsourced. Though, late life cycle outsourcing continues to have the highest share with API manufacturing outsourcing the highest at around 55 per cent

Enhanced domestic demand
The biggest upside for the industry however is going to come from the exponential growth of the domestic formulation industry. Almost 75% of the demand for APIs for domestic formulations market is met with domestic production and this has been consistently increasing. The need for low-cost APIs (that meet GMP standards) is expected to drive domestic growth of the API industry from $2.5bn in FY2010 to $5.3bn in FY2015.

Prognosis – 2011-2020
The Indian API Industry has come a long way since those days when majority of the players were SMEs and the sector was perceived as a “sweat-shop”. Most large Indian companies have built global scale and competitive facilities with API capabilities as the fulcrum. The last decade has been a dream decade for several companies – the industry today has several USD 100 million players. While growth opportunities are immense, we believe that the path would be tumultuous for the smaller players. Stretched balance sheets, questionable SHE practices and increasing price erosion issues would continue to plague the API entrepreneur.

Would the standalone API model continue to work? There is no reason to believe it cannot. In fact, companies are looking at growing through CRAMs; it’s a crucial non-conflicting USP. However, within CRAMs one would witness companies offering an integrated service offering

Also, the sector continues to witness further fragmentation and consolidation, which would only benefit the sector in the longer term. Companies sub Rs 100 crore would find it difficult to survive in the longer term and would be ideal M&A targets for the larger players.

Lastly, it would also become imperative for policy makers and the government to recognize that in order to strengthen the Indian pharmaceutical industry it is important to first support the API industry. Encouraging R&D investments through low cost loans, building common SHE infrastructure through cluster mechanisms and encouraging SMEs to upgrade their sites are imperative initiatives that would need to be supported.