Exit the dragon Indian drug makers are trying to shake off their dependence on China

Geetanjali Shukla Edition: May 27, 2012
It's a no-brainer that buying from a Chinese supplier is cheaper than from a Japanese one, right? Pravin Herlekar, Chairman of Omkar Speciality Chemicals, a Rs 100-crore bulk drug maker based in Badlapur, near Mumbai, learned the hard way that it is not always true. His company dumped its Japanese supplier of selenium when it found a cheaper source in China. But, Herlekar says, the Chinese suppliers resisted inspection of shipments before delivery. Within a few months, the intermediates that Omkar made using Chinese selenium began to suffer from quality issues. The company went back to sourcing selenium from Japan.

"Chinese suppliers often don't agree to third party inspections which help keep a check on quality," says Herlekar. Selenium derivatives are used to make an active pharmaceutical ingredient (API) or bulk drug. Bulk drugs are used to make medicines. For instance, intermediate compounds such as isobutyl benzene, aluminium chloride and sodium dichromate are used to make ibuprofen, the principal ingredient in formulation brands such as Combiflam.

With strong advantages such as economies of scale and government funding, Chinese companies have been flexing their muscles by resisting inspections, neglecting quality issues and raising prices. Many Indian companies are finding or creating alternatives to Chinese suppliers"
Lower prices offered by Chinese companies have caught the attention of many Indian drug makers. "In the last five years, API imports by Indian companies have doubled. In 2010/11, imports crossed $7 billion, of which China has a 60 per cent share," says O.R.S. Rao, Director, Cygnus Business Consulting and Research. "In the same period, India's bulk drug production has fallen to 35 per cent of its consumption, from about 70 per cent." The Hyderabad-based research firm releases a study on the Indian bulk drug industry every two years; the last edition was published in 2011. The Indian bulk drug market is valued at $13.5 billion, and its Chinese counterpart at $30 billion.

China and India are the leading players in bulk drugs, accounting for more than 40 percent of global bulk drug production. China is the largest bulk drug supplier, and India is second. Part of China's competitive advantage comes from the operating environment (lower interest rates, access to power and other infrastructure) and government aid (cheaper land, government funding). This has enabled Chinese manufacturers to benefit from economies of scale. China is also better endowed with raw materials such as phosphorous, potassium and sulphur. So it can produce bulk drugs at 10 percent of the cost in developed countries.

In 2010/11, bulk drug imports by Indian companies crossed dollar 7 billion, of which China has a 60 per cent share: O.R.S. RaoGiven their strong advantages, Chinese companies have been flexing their muscles by not allowing inspections, neglecting quality issues and raising prices. And Indian pharma seems to have finally decided that it needs to stop depending on China. Some Indian companies are integrating their operations backward to increase control over bulk drugs and intermediates. And, as price increases by Chinese manufacturers squeeze margins, Indian companies are trying to move up the value chain into the high-margin formulations business. Dependence on China has generated enough concerns for the Indian Drug Manufacturers' Association (IDMA) to call for anti-dumping duties on some bulk drugs and intermediates from China. IDMA also wants the government to set up a $700-million fund for bulk drug manufacturers. "Low-priced Chinese APIs are attractive, but this phenomenon can only be temporary," says Manish Doshi, President, IDMA.

"Nothing can stop them from raising prices once they know that Indian API manufacturers have closed down due to cut-throat competition. It is the government's duty to protect the industry from such dumping tactics by China." Doshi is also Managing Director at Amoli Organics and Umedica Laboratories, companies which were set up by his father and which make intermediates, bulk drugs and finished drugs. Naresh Gupta, who heads Lupin Laboratories's bulk drug unit, also argues that the government should try to level the playing field for Indian manufacturers. Incidentally, Lupin is the only Indian pharma major that exports bulk drugs to China.

Omkar Speciality Chemicals isn't waiting for the government act, however. Its strategy is to meet international standards. Its Badlapur factory has good manufacturing practices (GMP) status from the US Food and Drugs Administration. Regulatory authorities in many countries grant GMP status, but the most important for Indian companies are the US and British authorities, besides Indian regulators. Omkar will also seek GMP status for its factory coming up in Chiplun, Maharashtra. Herlekar says his advantage will be quality. "Indian formulations majors are increasingly sourcing from India, as they don't have to maintain large stocks and quality can be controlled," he says. "Most Indian API and intermediates manufacturers get their facilities audited by their customers, so quality isn't much of an issue."

Another strategy is backward integration. Shasun Chemicals and drugs, a Chennai-based Rs 1,000-crore company, has decided to manufacture some intermediates at its Andhra Pradesh plant, rather than importing them from China. Managing Director S. Abhaya Kumar says: "We have earmarked Rs 70 crore to move production of some of our key intermediates to India. The shift should be complete by December." He adds that intermediate prices in China have increased by 10 per cent in the last three months, because of rising petroleum prices and pressure on China to adhere to environmental norms. Shasun is the largest producer of ibuprofen in the world. It is developing 13 APIs for a few billion-dollar drugs whose patents expire in the next five years.

Another way to integrate backward is to acquire a bulk drug maker. For example, Mumbai-based Aanjaneya Lifecare bought intermediates manufacturer Apex Drugs in February for Rs 250 crore. The aim is to reduce dependence on third parties and reduce its vulnerability to fluctuations in price and supply. Similarly, Indoco Remedies, also based in Mumbai, acquired bulk drug maker La Nova Chem in 2006. The contribution of bulk drugs to overall revenues is negligible, but Indoco plans capital expenditure of Rs 55 crore over the next couple of years in its bulk drug factory at Patalganga, near Mumbai.

To counter the Chinese, big Indian drug makers such as Dr. Reddy's, Ranbaxy and Lupin have been moving up the value chain, from intermediates and bulk drugs to generics. But not everyone finds it easy to walk away from China.

"Only intermediates that have an impact on the quality of the finished product are manufactured in India or inhouse," says Sanjay Bhanushali, Head of International Business at Cipla. Procurement from China has increased five to eight per cent every year for the last three years." Cipla is looking at stronger alliances with other Indian or overseas companies to avoid sudden shocks. It is also open to dealing with companies in other markets, such as Brazil, Argentina, and Vietnam.

Lupin's Gupta says his company's Japanese operations are looking to shift all bulk drug manufacturing to India. "Despite price volatility in some inputs, the company was able to insulate itself due to hedging," he adds. Quality and research differentiate India from China. India has more than 175 plants approved by the US FDA - the highest number outside the US. Focus on quality has helped Indian companies increase their presence in developed markets. According to a report published in April by HSBC Global Research, half the Drug Master Files (DMF) in the first three months of this year are from Indian companies, compared to China's share of 14 per cent. DMF documents contain complete information about a drug's chemistry and manufacturing process, among other things, and enable a company to protect its intellectual property.

Many medium-sized bulk drug manufacturers have, with investments in research and development, shifted focus to late-stage intermediates and complex synthetic APIs. Chandigarh-based Parabolic Drugs , a Rs 900-crore company, recently commissioned a facility to manufacture bulk drugs in new therapy areas such as oncology and lifestyle ailments such as diabetes. The facility is likely to generate revenues of Rs 50 crore to Rs 75 crore in the current financial year and when fully operational, can generate up to Rs 300 crore.

But in the near future, it looks as if Chinese companies will continue to bleed Indian bulk drug makers. The capital-intensive nature of operations and extended working capital cycles have suppressed their return on capital. "Many bulk drug manufacturers are struggling financially," says Ajit Mahadevan, Partner - Life Sciences, Ernst & Young. "A lot of them are looking for funds and finding it difficult to manage them in these times." It may be a while before they are strong enough to fend off the dragon.
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