Analysis of effect of external environment on current structure

Regulatory Environment in India

The Drugs and Cosmetics Act, 1940 (Drugs Act) and Drugs and Cosmetic Rules, 1945 (Drug rules) regulate the import, manufacture, distribution and sale of drugs in India. Central and State government both are responsible to enforce disciplines under these acts. State authorities are responsible for regulating the manufacturing, sale and distribution of drugs, whereas the central authorities are responsible for approving new drugs and clinical trials, laying down the standards for drugs, controlling the quality of imported drugs and co-ordinating the activities of state drug control organisations.

Source: Crisil Research

Regulation in India is done on patents, price and quality.

Patents:
Till 2004 the focus was on process patents. That resulted in a lot of unethical reengineering of existing products. From 2005 product patents started in India. This prevents the reengineered products in the market.

Price:

The Drug Price Control Order (DPCO) fixes the ceiling price of some APIs and formulations. The APIs and formulations falling under the purview of the legislation are called scheduled drugs and scheduled formulations.

Quality:
No drug in India can be stocked, sold or distributed unless it meets the quality standards laid down by Drugs Act.

PEST Analysis
Political factors
Over the years, the industry has witnessed increased political attention due to increased recognition of the economic importance of healthcare as a component of social welfare. Political interest has also been generated because of the increasing social and financial burden of healthcare. Also, uncertainty in the political environment also impacts the investments and the investor confidence. The patent act has also impacted the pharmaceutical industry. Some of the key highlights are as below: With amendment of patent laws, products under patent cannot be launched in India. Innovator companies are lobbying for making more stringent patent laws which could make selling of patented products more difficult Developed countries are constantly making stringent regulatory systems (GMP) resulting in increased in manufacturing cost. DPCO plans to bring more drugs under price control Pharma SEZs Import & Excise duties Animal Rights organizations raising concerns

Economic factors
The per capita income of the people determines the extent to which people are willing to spend on healthcare. In India, majority of people visit doctors only in case of emergency. Only very few percentage of people visit doctors for regular health check ups. Also, in the past decade, the pharmaceutical industry has witnessed high value mergers and acquisitions. Hence, the Indian products have started to cater to global markets as well. This has led to rapid development of the industry. Some of the key highlights are as below:-

As cost of healthcare is shooting up in developed countries there will be want for quality generic drugs in USA, UK, and Europe. Dr Reddys with its brand name can penetrate these markets. Low spending in India (1% of GDP) Increasing output cost due to increasing inflation Lack of proper infrastructure facilities Low labour costs Increase in per capita consumption of drugs Increase of population Increasing healthcare industry penetration

Socio cultural factors

In India people prefer using household treatments handed down for generations for common ailments. Though this practice has seen drastic decline in the recent past, it is not completely wiped out yet. The use of magic/tantrics/ozhas/hakims is prevalent in many under developed rural areas. Also, increasing population, increase in pollution has resulted in increased health problems. But the effect of intense media and political attention has resulted in increased industry efforts to cater to all segments of the population. Some of the key highlights are as below: As disposable income of people is rising and are becoming more health conscious, demand for products such as nutraceuticals, multi vitamins are rising. Eg Success of Rivital by Ranbaxy lab. Poor sanitation and polluted water sources cause illness and deaths People prefer household medicine and treatment for common ailments Lack of awareness due to low education levels

Technological advances
Newer medications for various ailments have been discovered due to improvements in technology which has led to more efficient research and development. New molecules and active ingredients have been discovered. Initial investment for Drug discovery is very high and about 15-20 years are required for developing one drug molecule. New molecule has to go through clinical trials. If clinical trials fail whole investment is lost. High end technology is required for selecting desired molecule. Thus Dr Reddys has to continuously upgrade technology and synchronize all the areas of drug discovery for minimizing failure risk.

Technological advances resulted in increased output and reduced costs Increasing use of IT Low R&D levels and focus of Indian firms, need for increased focus New drug delivery system (NDDS) an advanced capability in formulations research

Legal factors
The pharmaceutical industry is a highly regulated and compliance enforcing industry. As a result there are immense legal, regulatory and compliance overheads which the industry has to absorb. In most of the cases, this tends to restrict its dynamism.

Porters Five Forces Analysis

a) The threat of new entrants
ECONOMIES OF SCALE: Economies of scale exist in the pharma industry. From the below table we can see that proxy variable (TE/TA) decreases with increase in assets indicating presence of economies of scale. This reduces the threat of new entrants and increases incumbents attractiveness. Company Total Expenses(TE) Total Assets(TA) TE/TA Dr Reddys Lab 4,048.00 7,465.00 0.542 Cipla 4,408.85 5919.16 0.745 Ranbaxy 4,536.77 9393.11 0.482 Lupin 3,496.90 4135.95 0.845

P RODUCT DIFFERENTIATION : Domestic market is branded market i.e. doctors generally prescribe the brand name. Different branded medicines exist for same disease and are perceived differently by both doctors and patients. So there exists product differentiation in domestic formulations market. However, the product differentiation is very less in the domestic bulk drugs market. The perceived product differentiation is less in exports market as it is mostly development market where doctors prescribe the underlying molecule. On a whole there exists product differentiation, and reduces the threat of new entrants and increases incumbents attractiveness. CAPITAL REQUIREMENTS : Below table shows the capital requirements and gestation periods USFDA approved plant Rs 20 30 crores Gestation-18-24 months Rs 15-20 crores Gestation-18-24 months Unapproved plant Rs 12 15 crores Gestation-6-12 months Rs 3-5 crores Gestation-6-12 months

Formulations Bulk Drugs

Above table clearly indicates low capital requirement and gestation period. However, the cost of producing an innovator drug is very high due to huge R&D expenses and also requires expertise in the drug discovery process. . On a whole there is low capital requirement, and increases the threat of new entrants and decreases incumbents attractiveness. SWITCHING COSTS : In the domestic formulations market, there are switching cost in terms of side effects from switching drugs and doctors/patients hesitation to shift to new brand or some unidentified generic version. However there are no switching costs for bulk drugs and exports market. On a whole there are switching costs, and decreases the threat of new entrants and increases incumbents attractiveness. ACCESS TO TECHNOLOGY /KNOW-HOW: Before 2005, when there are process patents instead of product patents, companies used to reverse engineer the product and get access to the technology and know-how. However, post 2005 as the era of product patents started getting access to technology/know-how has become difficult. However the molecules for which patents have expired can be reverse engineered and there are many patent expired drugs brands like Lipitor, Nexium, Zyprexa and Plavix providing huge opportunity. On a whole we can say that there is moderate difficulty in getting access to technology and know-how and makes the industry moderately attractive for incumbents. ACCESS TO RAW MATERIALS: Below is the Value chain of Pharma Industry

Getting access to chemicals/intermediates and APIs is relatively easy as there are many suppliers. So there is threat of new entrants and incumbents attractiveness is low. ACCESS TO DISTRIBUTION CHANNELS: Medical representatives, distribution warehouses, doctors prescription and medical stores constitute the distribution channel for most of the drugs. In India it is easy to get access to these all distribution resources. So there is threat of new entrants and incumbents attractiveness is low. GOVERNMENT P OLICY/PROTECTION: Indian Government regulates the pharma industry in terms of Patents, Price and Quality. Though government requires adhering to patent rules and quality standards, it has taken lot of initiatives to promote domestic pharmaceutical industry. It increased import duties for foreign drugs, recognized pharma as knowledge based sector, reduced interest rates for exports financing, tax deductions for R&D expenses, plans to setup VC for pharma financing, SEZs for pharma, Pharma Vision 2020, 3000 Jan Aushadhi stores and reduced the drugs under price control. So there is threat of new entrants and incumbents attractiveness is low. On a whole, we see that Government gives lot of push to encourage new players in the industry increasing threat of new entrants and decreasing incumbents attractiveness.

b) The bargaining power of buyers

NUMBER OF BUYERS : For the formulations, patients are the actual end users. But they use it mostly on doctors prescription. So doctors can be considered as final buyers and have considerable power. This considerably reduces the number of buyers and increases their bargaining power. P RODUCT DIFFERENTIATION: As seen earlier, there exists product differentiation reducing bargaining power of buyers. AVAILABILITY OF SUBSTITUTES : Major substitutes are generics, biosimilars, and holistic medicines like homeopathy and aurvedhic medicines. Currently use of all these substitutes is very less compared. Use of biosimilars and generics is considerably increasing and can pose as a proper substitute in the long run. So currently influence of substitutes is less and reduces the bargaining power of buyers. SWITCHING COSTS : As seen earlier, there are switching costs reducing bargaining power of buyers. BUYERS PROFITABILITY : In the pharma industry doctors can be considered as buyers for medicines and formulations manufacturers are buyers for bulk drugs. Both of them have considerable profits reducing their bargaining power. BUYERS THREAT OF BACKWARD INTEGRATION: There is no buyers threat of backward integration as most of the market is retail. So we can say there is no threat of backward integration from buyers and reduces their bargaining power. INDUSTRYS THREAT OF FORWARD INTEGRATION : There is little threat of forward integration i.e. formulations manufacturing opening up hospitals, as organized health care sector is small compared to unorganised sector. So there is no threat of forward integration from industry and increases bargaining power. CONTRIBUTION TO BUYER S QUALITY: Formulations and bulk drugs contribute extensively to the buyers quality. Effectiveness of medicines prescribed by a doctor will determine the quality of service provided by doctor and the API molecule supplied by bulk drug manufacturer forms core of formulations preparation. This reduces the buyers bargaining power. CONTRIBUTION TO COST :

Contribution of medicines to the health care costs and bulk drugs to formulations cost is high. This provides reason for buyers to bargain and increases their bargaining power.

c) The bargaining power of Suppliers

NUMBER OF SUPPLIERS (CONCENTRATION RATIO ): Chemical companies and API producers form the key suppliers to the pharma industry. Number of chemical companies compared to bulk drug producers and number API producers compared to Formulation manufacturers is high. So, bargaining power of suppliers is less. Also most of the top pharma firms make their own APIs completely eliminating the supplier power. AVAILABILITY OF SUBSTITUTES : Only inorganic compounds of chemicals, intermediates and APIs form the raw materials to the industry. There are no other substitutes available. This leads to high bargaining power of suppliers. SWITCHING COSTS : There are no switching costs involved in changing from one supplier to another. More or less these raw materials are commodity chemicals without much differentiation, so there are no switching costs. This leads to low supplier bargaining power. SUPPLIERS THREAT OF FORWARD INTEGRATION: There is considerable threat of supplier forward integration. There are instances in the past of this integration happening. Orchid Chemicals and Sashun Chemicals were basically chemical companies, who turned themselves into pharmaceutical companies. This threat results in higher bargaining power of suppliers. INDUSTRYS THREAT OF BACKWARD INTEGRATION: There is also considerable threat of backward integration, with bulk drug manufactures entering into chemicals business and formulations manufacturers into bulk drugs business. All top pharma companies have their own bulk drugs business. This reduces bargaining power of suppliers. INDUSTRYS IMPORTANCE TO THE SUPPLIER: Many chemical companies and bulk drug makers produce their products exclusively for pharma industry, so industrys importance is very high for suppliers. This reduces the bargaining power of suppliers. DIFFERENTIATION OF SUPPLIER PRODUCTS : There is not much differentiation in the supplier products. So there is no supplier bargaining power. CONTRIBUTION TO QUALITY: Chemicals and API form the core of products manufactured in the pharma industry. So suppliers contribution to the quality of product produced is high. For this reason all top pharma companies either produce APIs themselves or implement strict supplier code of conduct. This results in increase of suppliers bargaining power.

CONTRIBUTION TO COST : Suppliers also contribute significantly to the manufacturing costs of pharma industry. Raw material costs constitute about 40-50% of total costs incurred. We can see that latest total raw material costs for group of 31 companies in the industry is Rs 16282.3 crores out of 33784 crores of total expenditure(around 48%). This reduces the bargaining power of suppliers.

d) The Threat of Substitutes

AVAILABILITY OF CLOSE SUBSTITUTES : In India, substitutes are available in terms of unbranded generics, biosimilars, and holistic medicines like homeopathy and aurvedhic medicines. Currently use of all these substitutes is very less compared to branded halopathy medicines. Use of biosimilars is considerably increasing and can pose as a proper substitute in the long run. Growth in insurance business in India might also increase usage of generics as in developed markets and can replace the current branded medicines. So we can say availability of substitutes is high and the threat is high. SWITCHING COSTS : There are considerable switching costs involved in changing to usage of substitutes. Switching to substitutes might also involve changing completely the treatment plan which is costly. Also there can be severe side effects because of switching to substitutes .On a whole due to high switching costs, threat of substitutes is low. SUBSTITUTES PRICE-VALUE: Generics, Homeopathy and Aurvedhic medicines are considerably cheaper than the branded medicines. This might pose as a threat of substitutes. P ROFITABILITY OF PRODUCERS OF SUBSTITUTES : Profitability of substitute producers is high compared to the pharma industry as their costs are very low. Generics manufacturer will not have any R&D costs and has less fixed costs due to less capital requirements. Though the prices of these substitutes are also less, their profitability margin is high compared to branded drugs manufacturer. So there is high threat of substitutes.

e) Intensity of rivalry among competitors

NUMEROUS OR EQUALLY BALANCED COMPETITORS : industry is highly fragmented with around 300-400 companies in organized sector and around 15000 unorganized small scale units. Altogether these players manufacture over 100000 drugs. Top player in the industry Cipla has 5.4% market share and top 10 companies have only 33% of total market share. Thus the concentration ratio is very low. After Indian Governments rule to implement product patents, now many foreign MNCs are eying to enter Indian pharma industry. Big global pharma companies like Pfizer and Glaxo are actively pursuing Indian markets. This will in turn intensify the rivalry in the industry. On a whole this factor indicates high intensity of rivalry and makes industry unattractive.

SLOWING INDUSTRY GROWTH: Indian pharma sector has grown at a CAGR of 15% over last decade and is expected to grow at the same rate for next 5 years. About 108 bn dollars sales worth drugs are going off patent in next 5 years presents huge generics opportunity. Also contract research and clinical trials services are expected to grow at 15-17% for next 5 years. All these indicate good industry growth prospects which will reduce the intensity of rivalry among competitors as there will be less price war to capture the existing market. F IXED OR STORAGE COSTS: The fixed asset turnover, which is one of the gauges of fixed cost requirements, is in the range of 3.5 to 4 times for bigger companies. For smaller companies, it is even higher. High fixed asset turnover indicates high motivation to create excess capacity and chances for price cutting. Also we can see from latest figures that the fixed costs form 25% of total expenditure (8740 crores out of 33784 crores). This is considerably high and indicates high chances of intense rivalry. P RODUCT DIFFERENTIATION: As seen earlier, there is product differentiation and perceived brand image for some companies. This reduces the intensity of rivalry. SWITCHING COSTS: In the domestic formulations market, there are switching costs in terms of side effects from switching drugs. Switching costs make the intensity of rivalry low. EXCESS CAPACITY LEVELS : As capital requirement and gestation period are low, all top players add new capacities as demand grows. However presence of many small players creates excess capacity levels and intensifies the rivalry. EXIT BARRIERS : Low exit barriers in the pharma industry make it easy for unprofitable firms to quit then add to capacity of industry. This lowers the intensity of rivalry.

f) Exit Barriers
ASSET SPECIALIZATION : Capital requirement is very low for pharma plants. Except the intangible assets like patents, there is not much asset specialization required for pharma. So exit barriers are low. F IXED COST OF EXIT: Fixed costs of exit are low. So exit barriers are low. GOVERNMENT RESTRICTIONS: There are no exit restrictions imposed by Government. So exit barriers are low.

References:-

www.indiabiznews.com www.pharmaceutical-drug-manufacturers.com Dr Reddys Lab Annual Report FY 2010 2011 www.dnb.co.in planningcommission.nic.in www.icra.in www.ficci-b2b.com www.icra.in www.cci.in