To understand the growth and emergence of the pharma industry in India, one needs to go back to the late 1980s and the early 1990s. That was when Indian pharma companies showed the most frenetic pace of growth. Stocks like Reddy Labs, Sun Pharma and Lupin went on to become multi baggers over a period of time. And all this was achieved in the process of becoming the world’s largest exporter of generic drugs and accounting for nearly 40% of the total exports of generics in the world.
The core of it all: the patent issue
From the very beginning India has followed the process patent regime rather than the product regime. Here is how it works. In a product patent regime, the manufacturer of the drug gets the patent of the product for a fixed number of years. However, after the patent period expired, other manufacturers were free to conduct a reverse engineering of the drug and redesign the drug with almost the same effect. That was possible in India because Indian patent regime permitted only process patents. So if the process of manufacturing was changed with minor tweaks, you could actually sell the drug as a full-fledged generic drug. It was this segment that was dominated by the Indian pharma companies. This process patent regime allowed Indian companies to set up factories to manufacture generic versions of off-patent drugs and sell them to the US at a much lower price.
Why did the US allow this to happen?
In a way, the US and most of the developed had their own interests in this practice. The typical formulations manufactured by the global pharma giants like Pfizer, Bristol Myers Squibb, Johnson & Johnson, Glaxo, Novartis etc was so expensive that most middle class Americans could not afford the drugs. That negatively impacted the quality of healthcare in the US. It was this phenomenon that led the US to permit generic exporters like India to make generic versions of the original drug and export it back to India. India offered a combination of solid engineering skills, a manufacturing ecosystem and low costs to make all parties happy. That was the way it worked; at least till about five years ago. So what changed?
In fact, quite a few things changed…
First and foremost, there was resistance building up within the US that most Indian generic manufacturers were pricing their drugs to steeply and making super normal profits. In fact, Hilary Clinton had made this an election issue and had promised to come down heavily on such usurious pharma companies. Secondly, competition emerged from other countries like Latin America, Turkey, South East Asia and Eastern Europe. These countries were able to produce the generics at lower rates and the competition put further pressure on the margins. Thirdly, the US wholesalers in the pharma business saw a spate of consolidations in the last few years and that has given them more bargaining power. This had reduced the pricing power of the Indian pharma companies. But above all, the US Food and Drug Administration (FDA) had found some real process related problems in the way India manufactured and tested its drugs. That was the crux of the problem.
US FDA finds some real lapses in the manufacturing ecosystem in India
In the last few years, the US FDA, in the course of its inspection, has found some glaring lapses in safety and hygiene standards in these places. For example, at a Wockhardt facility, the FDA found a toilet drain just next to a sterile facility. At Dr. Reddy Labs the FDA found malfunctioning equipment at its testing centres. In fact, the Halol plant, the largest Sun Pharma facility which accounts for a bulk of its US exports, had to shut down production for some time due to serious lapses in safety and hygiene standards.
That is not all. In the last few years, the US FDA has also found reasons to believe that even the safety certifications of man generics may have been flawed or the side effects of such drugs may have been inadequately tested. It is not surprising that the number of drug quality checks by the US FDA increased by 18% in the year 2018 itself.
What does this hold for the future?
For starters the Indian pharma industry needs to learn to live with lower margins and lower growth. Competition is real and the US wholesale business getting consolidated is also for real. It means that Indian pharma companies will have to get used to lower valuations in sync with their growth potential. But above all, the FDA issue could be the real overhang. As the US FDA has been remonstrating over the last few years; Indian standards of safety and hygiene are just too pathetic. The earlier Indian pharma companies get the house in order, the better it will be for the industry as a whole!