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A project report on


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Contents Contents...................................................................................................................................4 B. SCOPE AND IMPORTANCE OF THE PROJECT.........................................................................7 C. RESEARCH METHODOLOGY..................................................................................................8 D. MY QUALIFICATIONS TO UNDERTAKE THE PROPOSED RESEARCH......................................9 E. LITERATURE SURVEY...........................................................................................................10 F. EXECUTIVE SUMMARY........................................................................................................14 1.1 Industry Segmentation by Size and Distribution...........................................................16 1.2 Top ten brands by global pharmaceutical sales............................................................18 1.3 Growth rate..................................................................................................................18 The growth rate for pharmaceutical industry was the highest in manufacturing 18


1.4 Industry Segmentation by Products..............................................................................19 1.5 Industry Segmentation by Distribution.........................................................................20 1.6 Industry Concentration.................................................................................................21 ........................................................................................................................................21 1.7 Current Environment....................................................................................................21 The U.S. pharmaceutical industry is expected to maintain above-average earnings growth through the end of the decade. .........................................................................21 1.8 The lifecycle of a drug...................................................................................................22 1.9 Research and Development..........................................................................................24 1.10 Pricing and investment in a global market..................................................................28 1.11 Relationship Pharmaceuticals – Healthcare................................................................33 1.12 Industry Living Space...................................................................................................34 2.0 GLOBAL PHARMACEUTICAL INDUSTRY.............................................................................34 3.0 THE INDIAN PHARMACEUTICAL INDUSTRY.......................................................................37 3.1 Introduction..................................................................................................................37 3.2 Evolution of Indian Pharmaceutical Industry................................................................43 3.3Competitiveness of the Indian pharmaceutical industry ..............................................75 3.3.1Post 2005 scenario......................................................................................................75 3.4SWOT analysis of the Indian pharmaceutical Industry...................................................79 Page | 4

3.5 Enviornmental analysis (PEST).....................................................................................81 3.7 Drug patents in India.....................................................................................................84 3.8 The future of Indian Pharmaceutical industry...............................................................87 4.0 THE TRIPS AGREEMENT.....................................................................................................91 4.1 Introduction..................................................................................................................91 4.2 Background...................................................................................................................92 4.3 The importance of intellectual property rights for national development...................93 4.4 WHO's perspective on globalization and access to drugs.............................................93 4.5 The history of the TRIPs negotiations...........................................................................95 4.6 Stakeholders' views.......................................................................................................96 4.7 Country experiences...................................................................................................105 4.8 Technical issues...........................................................................................................107 4.9 Standards for patentability........................................................................................109 4.10 Compulsory License..................................................................................................111 4.11 Parallel import..........................................................................................................113 4.12 Exceptions to the exclusive rights.............................................................................113 4.13 Roadblocks on the pharmaceutical competition highway: Strategies to delay generic competition......................................................................................................................114 4.14 IPR in the Indian context...........................................................................................123 4.15 A possible solution to the product patent issue........................................................129 5.0 MERGERS AND ACQUISITIONS (M & A)...........................................................................130 5.1 Historical Background ................................................................................................130 5.2 Mega-Deals Back on Pharma M&A Horizon................................................................131 5.3 Winners and Losers in Pharmaceutical M&A..............................................................132 5.4 Surviving the Scramble................................................................................................132 5.5 Facts on the Three Cases of Megamergers.................................................................132 5.6 Recent M&A................................................................................................................135 5.7 Steps involved in Mergers and Acquisitions (M&A): ..................................................140 5.8 Reasons for mergers and acquisitions ........................................................................140 5.9 Mergers, Acquisitions and Alliances: Why they can Fail.............................................142 5.10 Indian Pharmaceutical: Ripe For Consolidation ........................................................143 5.11 Impact of Mergers and Acquisitions on Performance...............................................145 5.12 The challenge............................................................................................................147 6.0 OBSERVATIONS...............................................................................................................150 Page | 5

7.0 SUGGESTIONS.................................................................................................................153 8.0 CONCLUSION...................................................................................................................154 9.0 PRELIMINARY REFERENCES.............................................................................................156

A. OBJECTIVE OF THE PROJECT The objective of this project is to provide a complete synopsis of the pharmaceutical market and to present the future prospects and also possible challenges that the industry may face in the times to come. The broad objectives of this report are: A.1 To study the development of the modern pharmaceutical industry and analyze the current situation, major challenges and the prospects of the industry; A.2 To study the growth and trend of Indian Pharmaceutical Industry; A.3 To study the bottlenecks in patenting and suggest suitable measures in the light of the problematic issues in patenting with a focus on TRIPS Agreement. A.4 To track the significance of Mergers and Acquisitions in consolidation of pharmaceutical industry.

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B. SCOPE AND IMPORTANCE OF THE PROJECT Medicines contribute enormously to the health of a nation. During the 20th century, the average life expectancy in developed countries increased by over 20 years. A significant part of this improvement can be attributed to pharmaceutical innovation. Few other industries can claim to have done as much for the well being of mankind. The interests of pharmaceutical companies and those of the public, patients and the government often overlap but they are not identical. An effective regulatory regime to ensure that the industry works in the public interest is essential. Unfortunately, the present regulatory system is failing to provide this. When the Financial Times (FT) listed the 50 largest businesses by market capitalisation in 31 March 2009, seven pharmaceutical companies were included. When it listed the 50 most admired businesses in 2009, only one of them - Johnson & Johnson - made it on to the list. This crisis in public trust must be faced. It is not in the long term interests of the industry for prescribers and the public to lose faith in it. We need an industry which is led by the values of its scientists not those of its marketing force. The comments of Sir Richard Sykes would be a guiding light to find medicines for healing the industry “Today the industry has got a very bad name. That is very unfortunate for an industry that we should look up to and believe in, and that we should be supporting. I think there have to be some big changes.� The







B.1 Quickly gain an overview into the pharmaceutical industry, its major companies and products. B.2 Identify key areas of pharmaceutical market growth and key opportunities for growth. B.3 Support internal planning and decision-making with an external perspective founded on detailed analysis.

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C. RESEARCH METHODOLOGY The methodology will include a comprehensive review and critical analysis of literature, particularly literature in pharmaceutical journals and other publications providing insights about the industry, challenges and opportunities. Among sources of the literature will be such publications as the Business Intelligence reports; research reports of Ernst & Young, Pricewaterhouse Coopers, Goldman Sachs, Deusche Bank, Stanford University, Kellog School of Management; websites of various organizations like the WHO, USFDA, WTO etc; various journals; and publications like Pharmabiz and Chemical weekly. Additionally, books, newspaper articles from such respected sources as the Wall Street Journal, Business Standard and other local newspapers will be reviewed, and pharmaceutical companies’ financial data, such as year-end income and expense amounts, will be analyzed. In the process of the comprehensive literature review and analysis, I will look for the current status of the global and Indian pharmaceutical industry, the effect of the patent regime and how it is being abused rather than used, various mergers and acquisitions and the real reason behind this.

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E. LITERATURE SURVEY Summary of some of the articles referred, appears below E.1 Pharmaceuticals - Market and Opportunities 2007 Ernst & Young Indian Brand Equity Foundation reveals that India Brand Equity Foundation (IBEF) is a public-private partnership between the Ministry of Commerce & Industry, Government of India and the Confederation of Indian Industry. It aims to effectively present the India business perspective and leverage business partnerships in a globalising market-place. The report provides extensive information concerning the industry. It includes a market overview, the policy-setting mechanism, key trends, drivers, and opportunities, and a brief overview of the performance of key players such as Ranbaxy, Nicholas Piramal, and Cipla. E.2 Patent Expiry of Blockbuster Drugs and Push for Lower Healthcare Costs Drive Generic Pharmaceuticals Market, August 15, 2007 is based on a research report by Frost & Sullivan namely U.S. Generic Pharmaceuticals Market Outlook, this article provides a brief overview of the impact of patent expiries in the U.S. generic pharmaceuticals market. Statistical information such as the present and estimated market size of the generic pharmaceuticals in the U.S. support statements made by the author. Besides numerical evidence, qualitative reasons for the growing significance of generics in U.S. (such as demand for lower healthcare costs) are furnished by the author. The article also discusses the measures pharmaceutical companies are taking to counter the problem such as consolidation, manufacture of branded generics, and backward vertical integration. Lastly, the article advocates that low-cost manufacturing locations will play a pivotal role since pricing pressures would intensify as lowcost versions of blockbuster generics take centre stage in the pharmaceutical market. E.3 Domestic drug makers immune to slowdown, Business Standard (March 13, 2009) PB Jayakumar in his article views the pharmaceutical industry as one of the few industries that is 'recession proof.' Testifying to this, the author cites growth data provided by pharmaceutical industry researcher ORG-IMS. Growth has been witnessed in a number of segments of the industry such as anti-infectives, gynaecology, vitamins and minerals, and respiratory drugs, in the month of January in 2009. According to the article, the growth of the domestic drug sector, which was just 6.8 per cent in November 2008, improved to 13.2 per cent in December and to 14.4 per cent in January. Further, information regarding companies' ranks based on total market share as estimated by ORG-IMS forms a part of the article. The numerous reasons for the buoyancy of the pharmaceutical industry in recent times find mention in the article along with the sources of this information. The reasons attributed to the industry's growth are better health insurance coverage, increasing rural penetration, rising population, and so on. Lastly, Estimations of the growth rate of the industry by few institutions (KPMG, Yes Bank) are cited by the author. Page | 10

E.4 Old is not gold? 2009 in Express Pharma Suja Nair says that among the most ignored segments of the pharmaceutical industry is the medicine for the elderly i.e. geriatric medicines. Exploring several reasons for the ignorance of this segment by the industry, the author provides an insight into the geriatrics market and the important place it will occupy in the future as today's young population grows old. The author states that there are a few companies such as Mumbai-based Elder Pharmaceuticals which cater to the medicinal needs of the elderly. However, geriatric medicines remain untouched to a large extent due to lack of clarity regarding the geriatrics market. The government has contributed to improving the situation by, among other things, formulating a national policy for aged under the Ministry of Social Justice and Empowerment. The author says that geriatric medicines need to be given more attention and this is possible through a strong pro-active government that starts and strengthens collaborations between the healthcare industry, insurance agencies and pharma companies. E.5 Government plans to make India, one of the top five pharmaceutical innovations hubs by 2020, will mobilize investment of two billion annually. Publication: PTI. Publication Date: 15-MAR-09, COPYRIGHT 2009 Asia Pulse Pty Ltd, By DEEPAK SHARMA in his article says that India is aiming to become one of the top five pharmaceutical innovation hubs globally, the government plans to invest up to 2 billion dollars, or Rs 10,000 crore, annually till 2020. The entire amount would be spent on developing more effective medicines to cure diseases such as malaria and tuberculosis that hits millions every in India and other developing countries. The spread of diseases is more in countries with lower income levels, making research in these areas less remunerative. Rich multinational drug maker are not willing to participate in this because this drugs fetch less profits. Taking this into consideration department of pharmaceuticals proposed to offer incentives to domestic as well as multinational drug makers to encourage new drug discovery in the country. According to them the proposal has the potential to add $20 billion to the GDP by 2020, along with creating lakh jobs. This proposal has already been sent to Prime Minister Manmohan Singh and are awaiting his approval. . Once they get the approval of the Cabinet, they will launch the programme within six months. According to them Africa, South Asia and Latin America are also huge markets for companies which would develop medicines for diseases such as malaria and tuberculosis. The government would invest in building infrastructure for R&D in the country and a significant amount from the proposed investment would be spent on upgrading human resources also. Besides this, the government is also working on framing regulations in such a way that it would promote R&D in the country. E.6 The Indian Pharmaceutical Industry – Prescription for growth published in 2008 - Care Research Report says that the playing field for the domestic pharmaceutical companies changed completely with the advent of product patent regime from January 2005. The IPI is now exposed to a host of new opportunities and risks. This has led the domestic pharmaceutical companies to pursue various strategies on the business and R&D front with the aim of achieving long-term sustainable growth under the new regulatory regime. Besides changes in the patent laws, the issues with respect to drug pricing and the Union Pharmaceutical policy will shape the regulatory environment for the industry in future. CARE Research believes that the growth of the Indian pharmaceutical companies in the domestic market get restricted Page | 11

with the MNCs introducing newer patented drugs in the country. It also believes that the growth of the Indian pharmaceutical companies in the domestic market get restricted with the MNCs introducing newer patented drugs in the country. Under this scenario, the growth for the formulation companies is likely to come from the generics opportunity in the regulated markets and geographic expansion in the semi/non regulated markets. The investment in R&D is also on the rise as it has become important for Indian companies to start innovating new drugs in order to ensure long term sustainable growth and remain competitive at the global level. E.7 Promoting Pharmaceutical Research under National Health Care Reform by Science, Technology, and Engineering Policy White Paper Competition 2008. Jacob Heller says the pharmaceutical industry is suffering a productivity crisis, brought on by soaring R&D costs and competition with generic manufacturers. Upcoming health care reforms in the US will curtail the remaining incentives for pharmaceutical research, but also provide us an opportunity for rebuilding a more efficient set of research incentives. Continued research into medical technologies is essential for improving the quality of life of Americans and eradicating diseases, and has historically proven exceptionally cost effective. To maintain robust incentives for medical research and to cure defects of the patent system, National Pharmaceutical Innovation Fund was introduced. The Fund will compensate innovators based on market success and medical efficacy, measured by Quality-Adjusted Life Years (QALYs). By setting proper incentives, the Fund marshals private sector efficiencies, expertise, and resources to innovating improvements in medical treatments. Pharmaceutical products have tremendous returns in increased lifespan and quality of life, making continued support an important national priority. E.8 Indian Pharmaceuticals and HealthCare Reports Q1 2009 article says that India holds an unchanged eighth position in BMI's Q109 regional Business Environment Rankings for Asia Pacific, remaining regarded as a moderately attractive proposition. India is fast-growing population representing one of the main drivers of pharmaceutical growth in the coming years, there are many barriers too like: · low per capita consumption · emphasis on generics (hampering the level of market development.) · excessive amount of red tape · underdeveloped infrastructure and · The deficient legal framework (although the government is striving to improve the regulatory environment). In December 2008, India's drug price regulator decided to lower prices of 46 brands and to include 254 new medicine brands in the list of price-controlled drugs. Meanwhile generics industry continues to expand, both locally and abroad. Zydus Cadila - a unit of Cadila Healthcare - purchased Italy-based Etna Biotech from Dutch biotechnology firm Crucell, while Sun Pharma acquired 100% of the US-based narcotic producer and importer Chattem Chemicals. On the other hand, Lupin recently became the third drug maker to be accused of sub-standard manufacturing by the US Food and Drug Administration (FDA), which will attract greater scrutiny on the sector as a result. Other Indian companies facing similar problems in the past include Ranbaxy Laboratories, Sun's' US-based subsidiary, Caraco Pharmaceutical Laboratories, as well as Wockhardt and Granules India. Growth of India's pharmaceutical export sector is down by more than half, Key reasons being increased competition in the highly regulated markets of the US and Europe and the steady appreciation of the

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rupee. Even victory of Barack Obama and the Democratic Party in the US general election in November 2008 will increase generic substitution in the world's largest pharmaceutical market, while the 2011 patent cliff provides yet the greatest opportunity for Indian generics exports. Nevertheless, generics are on winning position when domestic front is considered. E.9 Uwe Perlitz( April 9,2009) in her research paper India's Pharmaceutical Industry course for globalization provides readers an insight into the Indian pharmaceutical industry, including topics such as its history, the segments within the industry, the change caused by the new patent regime since 2005, its key growth drivers, exports, Indian companies investments abroad and so on. Detailed research has been carried out which is apparent throughout the report. The information conveyed through the report is supported by substantial evidence which have been gathered from DB Research itself and a few external sources. The report outlines India's position in the world pharmaceutical market as well as its standing among Asian countries. Summarily, the paper mentions the changes needed to be made for the pharmaceutical industry to rise and flourish. Since the paper includes valuable information about the pharmaceutical industry, it would be of great aid in making the report. E.10 Jacob Heller and Gabriel Rocklin (2008) in the article Promoting Pharmace-utical Research under National Health Care Reform brings to light the current problems and scope of improvement of the Drug and Pharmaceutical sector of United States of America. It puts forth the ‘patent system’ which hinders the future growth of this sector. There is a need to start focusing on preventive measures which could be only attained by channeling funds towards research and development in drugs and pharmaceutical sector. Complacency can be the reason for the doom of this sector. Thus innovative steps should be taken in time as an impetus to this sector. Especially during these troubled times. The future is positive for research and to make Medicare be preventive rather than just be used for curing. E.11 Manjeet Kripalani (March 25, 2008) in her article Indian Pharma: Hooked on the Hard Sell talks about the unethical marketing practices being carried out by pharma companies in India. Some pharma companies tend to engage themselves in aggressive marketing tactics which include showering physicians, pharmacists, and wholesale distributors with expensive gifts. In return doctors may prescribe drugs based on company incentives rather than the needs of patients. Here the author emphasizes the need of a regulatory body to in India to take care of the patient’s well being. To look after this concern the Organization of Pharmaceuticals Producers of India has published a voluntary "Code of Pharmaceutical Marketing Practices," that calls for maintaining strict ethical standards when conducting promotional activities. And soon this code would be converted into law. Hence it is clearly evident that though the Indian pharma industry has been growing enormously in the past few years and has been coming up with new high quality, competitively priced, generic drugs, but this success story is not as glamorous as its seem to be.

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F. EXECUTIVE SUMMARY India's pharmaceutical industry has been growing at record levels in recent years but now has unprecedented opportunities to expand in a number of fields. The domestic industry's long-established position as a world leader in the production of high-quality generic medicines is set to reap significant new benefits as the patents on a number of blockbuster drugs are scheduled to expire over the next few years. In addition, more and more governments worldwide are seeking to curb their soaring prescription drug costs through greater use of generics. These opportunities are presenting themselves not only in India's traditional wealthy client markets such as the U.S. and European Union nations but also in emerging economies with vast populations such as Africa, South America, Asia, and Eastern and Central Europe. In addition, India's long-established position as a preferred manufacturing location for multinational drug manufacturers is quickly spreading into other areas of outsourcing activities. Soaring costs of R&D and administration are persuading drug manufacturers to move more and more of their discovery research and clinical trials activities to the subcontinent or to establish administrative centers there, capitalizing on India's high levels of scientific expertise as well as low wages. Both multinational and local drug manufacturers could eventually benefit from the market potential of India's population of over one billion. A large market will likely open up as the result of a projected boom in health insurance, an area in which the country is currently woefully underdeveloped. New government initiatives seek to enable the majority of the population to access the life-saving drugs they need, while even greater opportunities may be presented by the rise of the new Indian consumer. This group-urban, middle class and wealthy-live fast-paced, Western-style lives and, as a result, they are beginning to suffer from Western, lifestyle-related illnesses, for which they want, and can afford, innovative drug treatments. This untapped domestic market is also highly attractive to the pharmaceutical MNCs, which recently have returned to India in large numbers (many had left when the regime allowing process patents only was introduced in the early 1970s). Now, MNCs and domestic companies are starting to work together, utilizing each other's strengths for their mutual benefit. For the foreign firms, this includes not only the Indian companies' research and manufacturing capabilities and their much lower operational cost levels, but also comprehensive marketing and distribution networks operating throughout India's vast territories. There are, however, a number of uncertainties, particularly the effects of India's new product patent system, which was introduced on January 1, 2005. Previously, only process patents were granted, a situation that led to India's current role as a world leader in the production of high quality, affordable generics. The new regime may spell the end for the domestic sector's smaller players, while for others it could represent unprecedented opportunities. Nevertheless, the domestic industry is still Page | 14

spending far too little on R&D, which must change quickly if it is even to begin to address these new opportunities and challenges. On the international front, the industry still has some catching up to do in terms of quality assurance while, on the local market, pricing remains a problem. There is a need for regulatory reform in India to encourage leading global players to continue and accelerate the outsourcing of their R&D activities-beginning with discovery research-to the subcontinent. This is particularly urgent in the face of the strong competition from China, where the government has been particularly proactive in encouraging foreign investments in pharmaceuticals and biotechnology. Action is required soon, if India wants to be a significant player in the global pharmaceutical arena.

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1.0 INTRODUCTION The modern pharmaceutical industry is a highly competitive non-assembled global industry. Its origins can be traced back to the nascent chemical industry of the late nineteenth century in the Upper Rhine Valley near Basel, Switzerland where companies like Hoffman-La Roche, Sandoz, Ciba-Geigy (the product of a merger between Ciba and Geigy), Novartis etc. started. The industry expanded rapidly in the sixties, benefiting from new discoveries and a lax regulatory environment. The industry witnessed major developments in the seventies with the introduction of tighter regulatory controls, especially with the introduction of regulations governing the manufacture of ‘generics’. The new regulations revoked permanent patents and established fixed periods on patent protection for branded products, a result of which the market for ‘branded generics’ emerged. Some of the big global pharmaceutical companies are Johnson & Johnson (U.S.), Pfizer (U.S.), Bayer (Germany), GlaxoSmithKline (U.K.), Novartis (Switzerland), Sanofi-Aventis (France), Hoffmann La-Roche (Switzerland), AstraZeneca (U.K./Sweden), Merck & Co. (U.S.), Abbott laboratories (U.S.). 1.1 Industry Segmentation by Size and Distribution The industry has been growing at a steady pace. Total global sales in 2008-09 was about $750 billion. Figure 1: India’s pharmaceutical industry on course of expansion

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Geographically, the world pharmaceutical market is divided as shown in the figure. Figure 2: Share of global market

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1.2 Top ten brands by global pharmaceutical sales In 2005, medicines for the treatment of high cholesterol, stomach ulcers, high blood pressure and schizophrenia were amongst the top ten brands worldwide. Table 1: Top ten brands

*COPD – Chronic Obstructive Pulmonary Disease 1.3 Growth rate The growth rate for pharmaceutical industry was the highest in manufacturing sector. Figure 3: Manufacturing trade average annual growth (%) 1994-2003

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Table 2: Rank of the 10 Causes of Death by Age Group (in United States, 2005)

1.4 Industry Segmentation by Products Pharmaceutical sales include: 1.4.1 Ethical (prescribed) drugs, which can't he dispensed without a physicians prescription; Page | 19

1.4.2 Over-the-counter (OTC) medications, which are readily available on drugstore shelves. Ethical drugs account for about 60% of total industry sales, with OTC products representing the balance. The ethical sector can be further segmented into: Brand-name products; Generic products. Generics are less-expensive equivalents of brand-name prescribed drugs, and may be produced and sold once the original drug's patent protection expires. Figure 4: Generic market shares in Europe 2006

1.5 Industry Segmentation by Distribution Three-quarters of industry sales consist of pharmaceuticals used in outpatient settings, with the balance administered in hospitals, nursing homes, and other inpatient facilities. About 70% of prescribed drugs are distributed through wholesalers to hospitals, health maintenance organizations (HMOs), and retail pharmacies. The

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remaining 30% is sold directly by manufacturers to physicians, hospitals, retailers, and others. 1.6 Industry Concentration The industry is somewhat concentrated. The 10 1argest players account for about onethird of worldwide sales of ethical drugs. Generic drug industry, in contrast, is fairly fragmented. Figure 5: Top ten companies worldwide by pharmaceutical sales

1.7 Current Environment The U.S. pharmaceutical industry is expected to maintain above-average earnings growth through the end of the decade. 1.7.1 Key global pull factors fuelling this growth include: rapid expansion in the older segments of the population; WHO forecasts the global over-65 population to rise from 380 million in 1997 to more than 690 million by the year 2025. increasing life expectancies; large untreated patient populations; Large markets overseas, especially in developing nations (like Russia and China)

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1.7.2 Key global push factors of growth are presented by: regulatory environment; Influence of the managed health care.

1.8 The lifecycle of a drug The diagram below shows the typical length of time that it takes for a new drug to go through the various stages of its life cycle (from patent to patient). Figure 6: The drug lifecycle

It is possible in the diagram to distinguish between components of the production process that can be considered 'international' (namely can be located anywhere in the world for supply to any given country) and those that are 'national' (that is need to be located in the country in question). As the diagram moves from left to right and becomes lighter, so the activities become increasingly 'national' in scope. More formally, the term 'international' is used to denote those stages of a drug's lifecycle for which: • the activity can be located anywhere in the world where a suitable environment exists • once the costs of that activity have been incurred somewhere in the world, they do not have to be incurred again in order to make the product available in other countries. Page | 22

R&D is an 'international' activity in this sense of the term, as it can be located wherever a suitable research environment exists, and once a drug has been developed the R&D cost does not need to be incurred again to make the drug available in other countries. In addition, some of the costs of global manufacturing facilities may also represent an 'international' cost element. The different stages shown in the chart above normally follow the patent application and are described in the next few paragraphs. Even before patent application, a considerable amount of time and money may have been spent on basic research to identify suitable entities for investigation, although much basic research is carried out in universities and publicly-funded institutes. Pre-clinical trials precede any testing on humans, and involve rigorous testing of selected NCEs in laboratories and animals. There are very high attrition rates at this stage of development: less than one per cent of compounds successfully make the transition from pre-clinical trials to clinical studies in humans. Clinical trials are carried out in humans. Three stages are carried out before drugs receive marketing authorisation, namely: • Phase I: trials in 20-100 healthy adults to test the drug's safety. 70 per cent of investigational new drugs (INDs) proceed successfully through Phase I • Phase II: trials in 100-300 patient volunteers to determine the safety and efficacy of the drug. A third of INDs make it through both Phase I and II, and • Phase III: trials on larger groups of patients (typically 1,000–3,000), to gain further data on safety and efficacy. Around 25 per cent of INDs progress through all three phases to a regulatory review. Marketing authorisation must then be obtained before drugs can be launched onto the market. Within the EU, there are two main routes for obtaining marketing approval: • a centralised procedure run by the European Medicines Agency (EMEA): new drugs may be granted a single marketing authorisation valid throughout the EU. • a mutual recognition procedure: firms first seek marketing authorisation in one Member State, but can then expect rapid authorisation in other Member States in the absence of any specific objections. After the drug reaches the market, Phase IV pharmacovigilance trials begin. These seek to identify any adverse drug reactions and continue throughout the lifetime of the drug. As discussed earlier, generic manufacturers are able to enter the market and sell generic copies of the drug after a drug's patent (and any supplementary protection certificate) has expired.

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1.9 Research and Development The drug industry is a research-oriented sector. Over the past years, the industry's R&D expenditures have risen sharply, both in value terms and as a percentage of total sales. A comparison of R & D expenditures in different industries appears below. Figure 7: R&D Expenditures as a Percent of Sales for US Industrial Sectors

Figure 8: R & D expenditures of the top ten pharmaceutical companies worldwide

Drug manufacturing is also a high-risk business; only one in 10,000 compounds discovered ever reaches the pharmacist's shelf.

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Figure 9: The economics of R & D

R&D costs per approved drug It is often reported that the costs of R&D per approved drug have risen considerably over the past 30 years. Let us explore available data relating to this assertion. R&D is not only a lengthy process but also a costly one. DiMasi et al (2003) calculated R&D costs for a sample of 68 drugs first tested on humans between 1983 and 1994. The results are shown in the table and figure below: Table 3: Cost of Research and Development at different stages

Figure 10: Breakdown of R & D spend Page | 25

Total 'out of pocket' expenditure on R&D (including the cost of R&D on drugs that did not successfully make it to marketing approval) averaged $403 million per approved new drug. Adding in the cost of capital between the time of R&D expenditure and the time of marketing approval increases this substantially—the capitalised value of R&D expenditure averages $802 million per approved new drug. In calculating capitalised costs, a real cost of capital of 11.0 per cent was used. DiMasi et al (2003)'s estimates suggest about 42 per cent of total capitalised expenditure on R&D is incurred in the preclinical phase but only about 21.5 per cent of drugs making it through the preclinical phase are successfully marketed. This illustrates the importance of unsuccessful R&D expenditure. Not only is a high proportion of R&D unsuccessful (in the sense that it is spent on drugs that are not ultimately approved for marketing) but, even for those drugs successfully marketed, a high proportion of revenue and cash flow is accounted for by a small number of 'blockbuster' drugs. Grabowski et al (2002) analysed global cash flows (sales value less production, distribution and marketing costs) through the life cycle for 118 new drugs entering the market between 1990 and 1994. They found that the single best selling drug (Zocor, the originator brand of simvastatin) accounted for nine per cent of the present value of cash flows and the top ten per cent of drugs accounted for 52 per cent of present value of cash flows. Comparison with earlier similar work suggests that R&D costs per approved drug are increasing rapidly (see Figure below). On the basis set out above (capitalised R&D costs per successful drug including unsuccessful R&D and the cost of capital), DiMasi et al (2003) estimate a compound annual growth rate of about 9.4 per cent between the 1970s and the 1980s, and about 7.4 per cent between the 1980s and the 1990s.

Figure 11: Trends in capitalised spend per approved drug (US $ Mn)

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$1,200 $802

$318 $138





Source: PhMRA Pharmaceuticals Industry Profiles 2007

The rapid increase in R&D spend per successful new drug shows that the productivity of expenditure has been falling. This reflects two trends. First, the absolute amount of R&D expenditure by the pharmaceutical industry has been rising rapidly over time. Second, the number of NCEs receiving approval has not been increasing and indeed has shown a steady decrease in recent years. Figure 12: The Pharma Productivity Gap

Fewer than a third of marketed drugs actually achieving enough commercial success to cover their R&D investment. Figure 13: Returns on Research and Development Page | 27

1.10 Pricing and investment in a global market Price-setting within an individual country is the outcome of bargaining between: • global pharmaceuticals companies (which may have market power in particular therapeutic areas), and • major health purchasers – typically national governments 1.10.1 Firm's objectives A reasonable assumption is that pharmaceutical firms will seek to set prices in order to maximise profits. We take this as our starting point in this analysis. For newly launched drugs, pharmaceutical companies are typically able to acquire a patent, granting them temporary rights to be the sole producer of that drug. In this case they will wish to maximise revenues, subject to a two types of constraints: • the range of demand side measures in place within the country concerned, including pricing and reimbursement policies adopted by the public buyer (which are likely to bite to a greater extent if therapeutic substitutes are available • international linkages, in particular the extent to which parallel trading and international reference pricing constrains the discretion the company has in setting prices in any individual country. For drugs whose patents have expired, pricing is constrained further through competition from generic manufacturers. In the absence of other structural or regulatory distortions, free competition between off-patent drugs should lead to significant drops in price. Pricing incentives Given that they have market power, it will be useful to identify pricing strategies that pharmaceutical companies are likely to adopt in different national markets so as to maximise profits. Typically, firms with market power will engage in price discrimination if they can segment their market into buyers with different degrees of Page | 28

price sensitivity, that is, by charging mark-ups above marginal cost in inverse proportion to the price-sensitivity of buyers. In this way, companies can extract as much rent as possible from buyers who are willing to pay higher prices, whilst not losing sales from buyers with a lower willingness to pay. (This is often described as 'Ramsey pricing', which is applicable where there are common fixed costs associated with sales to different segments of a market. In such circumstances, an efficient way to recover these fixed costs is to set prices for each customer group such that the mark-up above marginal cost varies inversely with the elasticity of demand). In the context of the pharmaceutical sector, this could mean charging different prices in different countries, depending on the price sensitivity of the national buyer or buyers. Generally, we might expect that countries with a lower national income per capita might be more price sensitive. In this instance, we would expect pharmaceutical companies to vary prices in relation to income per capita in each country. It is worth noting at this point that such pricing behaviour may be beneficial for Society overall (considered from a global rather than a national perspective), as well as being in the commercial interest of firms. In order to understand why this might be the case, the starting point is to remember that R&D is a globally common cost and forms a substantial proportion of the lifetime cost of a drug. In order for firms to have an incentive to engage in R&D, they must have an expectation that they will be able to recover the cost of R&D, at least on average across all drugs. This means that they have to be able to charge prices (somewhere in the world) which are above the marginal cost of manufacturing and marketing drugs. The relevant question is, therefore, what pattern of mark-ups across countries represents the fairest and most efficient way of allowing firms to recover R&D costs. Some have argued that this form of price discrimination may represent the best solution: • on efficiency grounds, setting differential prices based on the price sensitivity of national buyers allows firms to recover R&D costs in a way which minimises any effect on the take-up of drugs, and • on equity grounds, if income per capita is the key driver of differences in price sensitivity between buyers in different countries, then price discrimination by firms will tend to have the effect that rich countries contribute more to the cost of R&D than poor ones. For this outcome to be efficient, however, mark-ups over marginal cost must be limited on average across all drugs to what is necessary to recover R&D costs (R&D costs might still be over- or under- recovered on individual drugs, because some drugs will be commercial successes and others will be failures). More importantly, the prices of drugs must reflect the value they bring to patients ( In formal terms, dynamic efficiency requires that investment, including R&D, is made up to the point where the present value of the total benefits to all patients (for whom the benefit exceeds the marginal cost) is greater than the present value of total costs). The pricing and reimbursement systems employed by major purchasers are a key tool in sending these signals. Page | 29

Parallel trade Pharmaceutical companies may be constrained from price discriminating effectively by parallel trading. Where significant price differentials exist between countries, there is an incentive for parallel trade (that is for third parties to engage in arbitrage by buying drugs in low-price countries and reselling them in high-price countries, after suitable repackaging or re-labelling). The existence of parallel trade will tend to weaken the ability of pharmaceutical companies to charge different prices, because if they seek to do so they risk losing revenue from sales in high price countries to parallel imports. In response to this, pharmaceutical firms may have an incentive to delay launch or avoid launching altogether in low price countries, so as to prevent them becoming a source country for parallel trade. Moreover, since average prices may be lower and parallel traders incur costs and earn profits from their activities, parallel trade may reduce returns to the innovating companies, undermining incentives to invest. Parallel trading thus imposes a constraint on pharmaceutical companies' ability to Price discriminate, with potential implications for their willingness to market drugs in low price countries and their incentive to innovate. 1.10.2 Government's objectives In 2002, total pharmaceutical expenditure in Australia equalled 1.3% of GDP. In comparison, total pharmaceutical expenditure was equivalent to 1.8% of GDP in the United States, 1.6% in Canada and 1.5% in Japan. Figure 14: Public and private expenditure on pharmaceuticals (percentage of GDP)

In their role as healthcare providers, we would expect national governments to be interested in maximising health outcomes for their citizens within the constraints of their health budget (This assumes that the healthcare budget is fixed. An alternative would be to view national governments as wishing to minimise healthcare expenditure Page | 30

for a given level of health outcomes. In practice, of course, it would be possible for the government to steer a middle course between these two approaches. For example, a saving in pharmaceutical expenditure could be used partly to increase other health spending and partly to reduce the overall health budget.) There are three principal objectives that governments might have in bargaining on pharmaceutical prices: • achieving reasonable pharmaceutical prices. If governments can purchase existing volumes of drugs at lower prices, this will release some of the healthcare budget for spending on higher drug volumes or on other healthcare treatments • ensuring that drugs are made available in their country. Clearly, there is a constraint on price-minimising. Governments have to offer pharmaceutical companies a price which is sufficiently high that they are willing to continue to supply the drug in that country. At a minimum, the price would need to cover the 'national' element of drug costs, and • ensuring that there are adequate incentives for R&D on valuable new drugs. In a longer-term context, governments' overall objective could be restated as maximising health outcomes for their citizens, both now and in the future, within the constraints of current and future health budgets. Within this longer-term framework, governments will wish to see new drugs being developed which will be of benefit to their citizens in the future. In negotiating drug prices, there should therefore be consideration of the implications for the incentives for pharmaceutical companies to invest in R&D. In practice, any pricing approach will involve a trade off between these objectives. In addition, there may be other non-healthcare objectives of importance to some governments in negotiating pharmaceutical prices, such as industrial policy objectives. In particular, they may wish to use high drug prices to attract footloose pharmaceuticals' R&D and production to locate in their country. However, given the international nature of R&D costs, such a policy is unlikely to provide incentives for firms to locate R&D in a specific country. Since national governments are the principal purchasers of pharmaceuticals in most countries, they are almost certain to have buyer power in the market for pharmaceuticals—that is, they will be able to influence the prices at which they buy drugs. We now consider how a government could use its buyer power to achieve the policy objectives outlined above. Reasonable prices Typically, if a firm has buyer power, it is able to take into account the effect that the quantity it buys has on the price of the product it is buying. The buyer will therefore buy a lower quantity at a lower price than would be the case in the absence of buyer power. If a single buyer is buying in a competitive market, where many suppliers compete on price, use of buyer power would lead to a loss of overall welfare if the costs of supply increase with total output (that is, there is a rising supply curve). In this case, however, the market from which the government buys is unlikely to be competitive, given that patents grant pharmaceutical firms temporary rights to be the sole producer of a particular drug. In order to analyse the government's best use of its buyer power, the starting point (or counterfactual) should in this case be taken as a monopoly, (In the case of the market for a drug, the existence of close therapeutic substitutes may mean that there are in fact several sellers of differentiated products: Page | 31

the case of a monopoly is presented for simplicity) where a single firm is able to exert its seller power by taking into account the effect the quantity it sells has on the price. As long as demand is not completely price inelastic, a monopolist will sell a lower quantity at a higher price than in a competitive market, leading to a loss of overall welfare. If there is a single seller and a single buyer operating in one market, there are a range of possible outcomes consistent with either side using their market power. Market outcomes (prices and quantities) may be determined as a result of negotiation between the two parties. Where two firms, both with monopolies, are involved, one might expect them to agree on a quantity that maximises joint profits (Including both the monetary profits of the seller, and the 'surplus' (non-pecuniary excess benefits) of the buyer) and then negotiate on a price. In this case, the quantity produced will be the same as in the outcome where there is only one monopolist, but the buyer may be able to negotiate a lower price, reallocating profits from the seller to the buyer. In principle, it may be possible in this way for national governments to use buyer power to negotiate lower drug prices (although, as discussed further below, one might also expect a government, concerned with its citizens health, to try to induce the monopoly to supply a higher quantity than that which maximises profits). Ensuring that drugs are made available Of course, in practice, governments are constrained in the extent to which they can push down prices by the threat that companies have not to supply the drug in question if a price cannot be agreed. Governments in turn can threaten to withhold reimbursement status. Hence the price bargaining process is best analysed strategically, with prices being agreed in the context of: • the threat of withholding reimbursement from government, and • the threat of pharmaceutical companies withdrawing the supply of a drug to a particular country Incentives to invest in valuable drugs The use of buyer power can also have effects on incentives to invest. In the context of pharmaceutical pricing, the long term objective of maximising health outcomes for people into the future implies that governments will wish there to be adequate incentives for R&D into new drugs. Ensuring that there are adequate incentives for R&D therefore forms a constraint on governments using their buyer power to negotiate as low drug prices as possible. The optimal set of drug prices from a government's perspective will therefore be the one that maximises all health outcomes (now and in the future), taking into account the effect that these prices will have on incentives for R&D into new drugs. However, the global nature of R&D costs means that the effect of prices in any one country (particularly a small one) on investment is less clear. Globally common costs and 'free riding' R&D is a globally common cost. If a country accounts for a small proportion of Global sales, sales in that country will have little effect on companies' global return

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from R&D. As a consequence, prices in such countries are likely to have little direct effect on the level of R&D and hence on the pace of pharmaceutical innovation. This could affect the incentives governments have in exercising buyer power. In particular, governments may face an incentive to 'free ride' on global R&D by paying prices which do not contribute to this cost element. In order to ensure the national supply of a drug, a government may seek to negotiate prices that cover only national costs and avoidable international costs, leaving the globally common costs to be paid for by other countries. Where governments seek to free ride in this way, companies may respond by delaying launch of a drug in that country, or even not launching at all. Furthermore, although free riding may be rational for an individual country, if many governments successfully adopt this approach then there would be significant aggregate effects on global returns to R&D and hence on companies' incentive to develop new drugs. In the light of this, governments may recognise their common interest in allowing higher prices that incentivise the development of new drugs. The objectives of the PPRS specifically refer to promoting an industry 'capable of such sustained R&D as should lead to the future availability of new and improved medicines' while our international survey of pharmaceutical pricing and reimbursement schemes suggests a number of countries do not just seek to set as low a price as possible but, for innovative drugs, seek to negotiate prices that reflect a drug's cost effectiveness. In principle, the solution to this problem would be to coordinate price setting between countries, ensuring that each paid its 'fair share' (possibly according to some measure of ability to pay). In practice, concerns to retain national sovereignty over drug pricing mean that such an approach is not likely to be implemented in the near or medium term. The incentive to free-ride may, however, be dampened by the practice of international reference pricing, which has the effect of linking prices in different countries. If prices are linked, an individual country may have a greater effect on global returns to R&D than the size of that country's pharmaceutical market might initially suggest. Therefore, these countries will have a greater incentive to take account of long-run effects on innovation when exercising their buyer power. 1.11 Relationship Pharmaceuticals – Healthcare 1.11.1 Managed Care Growth: The shape of the pharmaceutical marketplace transforms rapidly due to growth of managed care in the U.S. healthcare system. The latter becomes more and more popular because of its ability to provide medical products and services in a cost-effective manner. Managed care's share of the retail pharmaceutical market, which was less than 30% at the start of this decade, is expected to reach 90% by the end of it. The managed care providers discount purchases of pharmaceuticals and medical products, as well as physician and hospital services, insisting on the use of low-cost generic drugs whenever possible. 1.11.2 Medicare and Medicaid: Managed care is also moving aggressively into Medicare and Medicaid markers. Medicare is the principal healthcare financing program for Americans 65 years of age and older. But the program doesn't provide Page | 33

reimbursement for outpatient prescribed drugs. Enrolling into managed care plans, medicare beneficiaries are typically given free or low-cost prescription coverage. Growth of medicare/managed care population increases drug utilization. Medicare/managed care enrollment has more than doubled over the past four years. Medicaid managed care plans are also poised for ongoing growth.

1.12 Industry Living Space 1.12.1 Demand: The demand for medicine is tied to the health of the populace, which is relatively constant over the years. Drug pricing is also relatively inelastic, due to the absence of alternate therapies for the most prescribed drugs. 1.12.2 Life cycle of products: The product cycle of nearly all prescribed drugs is fairly stable. After the average 10- to 15-year period of discovery, development, testing, and FDA review, a branded ethical drug has about 10 years of commercial life. 1.12.3 Discovery: New drugs are discovered in scientific laboratories. The process is long and laborious, with the vast majority of attempts unsuccessful. 1.12.4 Bringing the drug to market: Before a drug can be brought to market, it must undergo years of testing and receive government approval from the FDA. It takes several years of sales buildup in major markets in the U.S. etc before a drug reaches its full commercial potential. At that point, new competition of drugs similar in action may enter the market. 1.12.5 Going generic: Generic competition usually appears immediately after patent expiry, and prices begin to fall. Branded prescription drugs effectively have about 10 years before generic competition erodes their profitability. 1.12.6 Going OTC: Companies sometimes switch a patent-expired product from prescription-only status to over-the-counter (OTC) status to broaden its market and extend its economic life. Competition in the market of OTC products is more straightforward. Margins on products switched to OTC status are lower than those on the prescription products they replace, but popular consumer medications can have almost infinite shelf lives.

2.0 GLOBAL PHARMACEUTICAL INDUSTRY Historically, the pharmaceutical industry was characterized as a high growth and high margin business with significant return on investment from new drug discovery and development. Even at current revenues, the pharmaceutical industry still represents Page | 34

only about 8% of total healthcare expenditures. However, given the fact that drugs are often an out-of-pocket expenditure, the pricing of drugs has come under a lot of scrutiny. Over the past two decades, the industry has also dealt with the emergence of a generic segment as products brought to market largely since the sixties went off patent and firms emerged to produce knock-offs that sold at much lower prices (today at about 15-20% of initial price at product launch). The industry has also found challenges in: •

The rising cost of new drug discovery and development through final FDA approval; estimated variously at $400 m to $800 m for each new product,

A declining product pipeline and the withdrawal of several blockbuster drugs from the market due to dangerous side effects impacting a tiny percentage of users,

The emergence of a biotechnology based pharma industry that is both a threat and an opportunity for traditional synthetic drug developers,

Legislative scrutiny on drug pricing and spending on marketing and sales, particularly in the US, while prices in many regions are far less,

Increasing emphasis on FDA enforcement of cGMP as a result of some recent problems as well as Canadian re-importation trends,

Drug safety issues resulting from the recent Vioxx and Celebrex market withdrawal,

Increasing complexity of drug molecules as the industry selectively targets specific diseases, with the result being declining potential patient populations,

Conducting clinical trials globally while ensuring uniform standards and genetic diversity controls.

Despite these issues and recent declines in earnings, the industry is forecast to grow at 8.2% per annum to 2011 to a total of $967 billion dollars. One final thought is that there has been rapid growth of the pharma industry in both India and China and they are steadily improving in quality while maintaining low cost and increasing innovation. It is projected that by 2010, China will become the fifth largest global pharmaceutical market. The value of pharma fine chemicals is first assessed at the active pharma ingredient (API) level, about 10% of total industry revenues or some $52 billion. The industry also supplies advanced intermediates for an additional value of some $20-25 billion and basic building blocks for an additional $10-12 billion. Thus the industry is valued in total at some $85 billion. Of this, an estimated 40% is sourced on the merchant market and the balance is produced by the captive operations of pharmaceutical companies. The key issue for API production is the ability of the supplier to produce in compliance with cGMP requirements set by the FDA in the US. To source or supply APIs and advanced intermediates in other regions, the FDA must still certify the plant site. Today, Europe lags the US in site inspections and the European pharma fine chemical industry sees this as a serious competitive risk. Specifically, large quantities Page | 35

of Asian APIs of questionable quality are entering the EU and undercutting the pricing of regional players. If this is not corrected, the industry believes both the safety of the public and the competitiveness of local manufacturers will be at risk. Historically, fine chemical producers were largely captive operations of integrated chemical and life science firms. A few large independents, Eastman Fine Chemical, EMS Dottikon and Lonza did emerge as early third party producers surrounded by hundreds of small ($5MM to $30MM) players. In pharmaceuticals, most production of fine chemicals was conducted by their internal manufacturing operations for security and regulatory risk management. As financial pressure to improve both the income statement and the balance sheet at big pharma companies increased during the 1990s, pharma companies moved to cut costs and extract value to support R&D and marketing by adopting chemical outsourcing strategies. In response, a merchant pharma fine chemical market emerged and has seen constant change through regulatory skill development, roll-up acquisitions, technology start-ups, consolidation, restructuring of both integrated chemical firms and pharma companies with a subsequent spin out of assets, and big acquisitions to secure step-change positions. Today, suppliers to the pharma (and general fine chemical) industry tend to operate in one of following modes from a manufacturing and technology perspective. First, is a full service provider that has both a broad range of production technologies and assets, including some which are either complex, hazardous or leading edge. Competitive position is achieved by being able to carry out multiple synthesis steps within a single supply chain and also contribute what may be a key technology practiced by only a few firms. Second, are the specialist players who differentiates and seeks to operate under the umbrella of the broad based supplier by focusing on a particular synthesis step (phosgenation for example) that may be hazardous or require unique equipment. These firms seek to outsource their specialty even from the large supplier. And a Third group have entered the pharma fine chemicals industry as start-ups driven by a new, unique skill (chiral separations or early stage process development and kilo scale production) or a unique position (chiral building blocks, peptide synthesis, or mammalian cell culture). A Fourth category of participants have emerged largely from India and China, that being low cost producers of the “me-too” products using a range of basic multi-step organic synthesis skills. These firms tend not to practice any unique chemistry and historically competed in their home markets while exporting opportunistically to the “west” purely on a cost basis. Early on, the quality from these largely Asian producers was highly suspect, but first in India and now China these quality gaps are being closed. The NA and European firms still have a lead on unique and emerging technologies and are the centre of innovation for the pharma industry, but their capital equipment and manpower cost positions are well above the Asian players, and the skill and education gap probably no longer exists. In fact, Indian pharma firms and NA and WE firms have begun to establish significant R&D operations in the region that may well lead to a true globalization of the industry. The early pharma fine chemical industry was considered highly attractive from a margin perspective as high prices could be charged for custom manufacturing services Page | 36

when compared with the internal cost of inefficient captive manufacturing. In fact, two of the early drivers of outsourcing were per kilo cost reduction and capital investment reduction that improved the ROCE of innovator drug companies. During the 1990s a generic pharma actives industry grew as patents on older drugs expired. This generics market fostered the growth of entrepreneurial players initially in Italy and Spain and later in India. As these firms grew in capabilities, they began to target a broader range of merchant business. The Indian industry, faced with limited brand equity chose to compete on price and drove the trend to competitive pricing and margin erosion in merchant pharma fine chemicals during the latter half of the 1990s. Another aspect of this competition was the shift from high initial margins on advanced intermediates and actives, with slow erosion of pricing during the early years of commercial production, to aggressive pricing and rapid erosion of per kilo prices and margins even on late stage clinical trial quantities. Rather than begin production of a new molecule with a price of say $1000/kilo and then manage its decline to maybe $600/kilo over time, competitive firms began actively bidding down prices even below the $600/kilo level in order to capture the long term supply commitment. In the early 2000s, as the pharma pipeline failed to deliver a growing number of new molecules and thus outsourcing opportunities, prices and margins took a further hit as too many players and too much capacity chased too few opportunities. With high capital costs due to inflated acquisition prices, excess often high cost capacity demanding rationalization, increasing competition from both Indian and Chinese suppliers, and reduced outsourcing by big pharma, firms such as Clariant, DSM, Rhodia, and Degussa have struggled to achieve desired growth and profitability. The pharma fine chemicals industry may be in a better position now to benefit from a recovery, if the product pipeline and pharma sourcing strategies move in positive directions. However, the industry is in serious need of restructuring because there are both too many players and too much capacity chasing too few opportunities, leading to continued pressure on prices and margins.

3.0 THE INDIAN PHARMACEUTICAL INDUSTRY 3.1 Introduction The Indian Pharmaceuticals sector has come a long way, being almost non-existing during 1970, to a prominent provider of health care products, meeting almost 95% of country’s pharmaceutical needs. The domestic pharmaceutical output has increased at a compound growth rate (CAGR) of 13.7% per annum. Currently the Indian pharma Page | 37

industry is valued at approximately $ 8.0 billion. Globally, the Indian industry ranks 4th in terms of volume and 13th in terms of value. Indian pharmaceuticals industry has over 20,000 units. Around 260 constitute the organized sector, while others exist in the small scale sector. India has large number of pharmaceutical companies that produce even very new inventions without license from the innovators. Antibiotics and nutritional supplements are important sector, and drug prices are very low compared to the ‘West’. The bigger pharmaceutical companies are back-integrated in the manufacture of bulk actives, although many source intermediates domestically or from abroad, particularly from China. The smaller drug companies source bulk actives from the many smaller fine chemical operations set up to produce fine chemicals for the domestic and overseas markets. Figure 15: Location of pharmaceutical hubs in India

Mainly based in the five major fine chemical and pharmaceutical manufacturing regions around Delhi, Hyderabad, Mumbai (Bombay), Ahmedabad and Bangalore, India’s thousand-plus companies have built up a formidable industrial strength, particularly since 1985.

Figure 16: Trends in the production of bulk drugs and formulations in India since the 1970s

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The pharmaceutical industry has witnessed tremendous transformation since the 1950s. The size of the Indian pharmaceutical industry, both bulk drugs and formulations is estimated at Rs 35,471 crore in 2003-04 (IDMA 2004), which is just over 1% of the global market (ICRA 1999). This is against the value of the production of pharmaceuticals of a mere Rs 10 crore in 1950. Investment in the industry has steadily grown over the years from a mere Rs 23.64 crore in 1950 to a moderate Rs 500 crore in 1980 and went up considerably to reach around Rs 4000 crore in 2003. Propelled by the booming demand, the production of pharmaceuticals has registered a tremendous increase over the years. Table 4: Growth rate of bulk drugs and formulations production in India since the 1970s

The growth rate of bulk drugs recorded in the 1970s and 1990s is almost doublearound 20%-that of the production registered for the 1980s is evident from the above table. The output of formulations has seen a phenomenal increase during the period under consideration but is less than 4% as against bulk drugs, in both the 1970s and 1990s. The 1980s is the only period in which formulation growth had outperformed the growth of bulk drugs by a marginal 1%. The massive growth of the pharmaceutical industry could be attributed to a few domestic and international developments that took place particularly since the 1950s. At the global level, the Page | 39

industry in general was then experiencing a major overhaul by vertically integrating operations such as production, marketing and research. The protection given to the pharmaceutical industry through patents and brand names saw many top companies switch over to the production of specialty medicines. Indian pharmaceutical fine chemical players have served their apprenticeship and are now embarking on their own voyage of conquest in this globalizing industry. Looking back to the early 1990s, a handful of modest sized Indian companies, including firms such as Ranbaxy, Cheminor and Dr. Reddy’s Laboratories, first appeared on the RADAR scope of industry participants in the United States and Western Europe. These Indian ‘upstarts’ looked to be an emerging threat to Western European fine chemical players, particularly Italian and Spanish firms, and some discovery based drug companies based on manufacturing and skilled labor cost advantages and limited protection for intellectual property. At the time there were questions about consistent quality, lack of FDA certification and even environmental practices that slowed their progress in international markets. But today we can say that the Indian pharmaceutical fine chemicals industry has learned its lessons well. Even a brief survey of the situation, reveals an Indian industry that has: many moderate to large players with a varied range of participation, even some with international operations, • •

management and financial resources to pursue acquisitions in other countries,

become a reputable source of building blocks, advanced intermediates and active ingredients to the growing global generics market • •

an improving track record with the FDA and other regulatory agencies,

skilled technical labor that can now support not only fine chemical process development and production but also clinical development and contract research. •

A key driver for significant growth in the global pharma fine chemicals segment (APIs, advanced intermediates and basic building blocks are normally about 17-18% of the total pharma industry value, or about $85 Billion in 2005) was the expected increase in outsourcing starting in the mid-1990s, based on the anticipation of very productive discovery and generic drug pipelines (today, approximately 40% of the value of this production is outsourced). Industry analysts expected the human genome project to lead to the introduction of new drugs of increasing complexity and these drugs would require competent outsourcing partners with real know-how to effectively bring this growing portfolio of life saving products to market, quickly and at acceptable cost. At the same time, an increasing number of older drugs would go through patent expiry and expand opportunities for generic suppliers. As a result, both technology start-ups and divisions of large chemical companies – jumped in to take advantage of the growing outsourcing opportunity. New cGMP capacity was built by suppliers of all sizes, and in the late 1990s several large chemical companies (e.g., Degussa, Rhodia, Clariant and DSM) made significant acquisitions to establish themselves as leading fine chemical and active ingredient suppliers to the pharmaceutical industry. This active capacity building, coupled with the improving quality of Indian and Chinese manufacturers created strong price competition and Page | 40

severe margin pressure on the fine chemicals industry. Margin pressure was further exacerbated by low productivity of the pharma drug pipeline, and the net result has been a wholesale consolidation of both fine chemicals and pharmaceutical industry participants. While this industry evolution has been playing out largely in “the west,” India’s pharmaceutical industry and thus its fine chemicals industry has also had to adapt to new realities. For many years the pipeline was regularly filled with new “me-too” products copied from global pharmaceutical majors. Today, India’s passage of a new Patent Law has raised the IP (intellectual property) hurdle so that Indian firms cannot produce patented active ingredients and dosage form pharmaceuticals in advance of patent expiry! This points to a near term slow down in growth in the domestic pharmaceutical market which will impact both pharma companies and the fine chemical supply network. However, larger players in the Indian pharma fine chemical industry have simultaneously been building their export businesses and that will provide for better growth prospects. At the same time, some Indian players have established foreign operating positions, often via acquisitions or alliances and are poised to take a larger role in this globalizing industry. While the Indian pharma fine chemicals segment has not been immune to the drivers of margin pressure, including: industry overcapacity (about 70-75% capacity utilization industry-wide), consolidation with continued in-sourcing by Western pharma companies, declining Chinese prices, and increased emphasis on quality – the “survival of the fittest” points to a significant new opportunity! And that is the ability to significantly extend its reach into foreign markets to offset slower growth in domestic markets. Today, Indian fine chemical companies can enter foreign markets both organically (playing on their cost advantage and adding further sophistication) and inorganically (several of the high-cost acquisitions of the past 10 years are being written down by firms such as Degussa, Rhodia, DSM and Clariant, and mid-size European and North American based companies are putting themselves on the block). Common belief is that while Indian Pharma fine chemicals companies can continue to position themselves as low cost commodity suppliers, the opportunity is open – through innovation and strategic thinking – to move up the value chain in multiple ways. Unlike China, India was an imperial colony at the end of the last world war (just) and so the emerging pharmaceutical companies (particularly British companies such as Beecham, Glaxo and later ICI) developed their business in India as part of their international operations. Drugs were priced at international levels, leaving the majority of the Indian population without realistic access to modern therapies. The patent regime and the law was identical to that in Great Britain and so no copy products could be produced at low cost (as was then practiced by all other Asian countries, as well as some European countries, such as Italy). Several Indian-owned (‘indigenous’) companies had been set up even before independence and they eventually (in 1971) persuaded the government of Indira Gandhi to repeal the country’s product patent laws, thus allowing the local companies to produce new drugs at a fraction of the price being asked by the multinationals. ICI’s propanolol and Beecham’s ampicillin were both specifically named in her speech in Geneva, in which she defied the West with the statement that no government should be able to ‘legislate against life’. An interesting parallel now exists in South Africa, where the new Page | 41

government is threatening to repeal product patents in order to gain access to low cost treatment for AIDS (the African pandemic of AIDS is threatening to undermine the future welfare of many countries in the region). Many multinationals (particularly the US-based ones) eventually withdrew from the Indian market, as a result of this action. The Indians have ‘called this multinational bluff’, however, and have been able to build up an impressive infrastructure to supply both the majority of its own needs and those of an increasing proportion of the Asian, South American and African export markets. Both finished drugs and bulk actives are exported. Today, the industry has reached a watershed, having accepted the reintroduction of product patents. It is the judgement of the government and its advisers that India has more to gain than to lose by acceding to the West’s demands. One third of its people still have no access to modern drugs, but from an Indian point of view, the country’s strategy has largely paid off. Most other Asian countries have not developed their own industries and have, as a result, become dependent on multinational companies (that sell at high prices that many of the people cannot afford) or WHO (which can only supply older, cheaper drugs that are often inadequate). The Indian pharmaceutical industry, which had little technological capabilities to manufacture modern drugs locally in the 1950s, has emerged technologically as the most dynamic manufacturing segment in the Indian economy in the 1990s. Besides, it generates rising trade surpluses in pharmaceutical products by exporting to over 65 countries, therefore, significantly competing with developed countries for global market share. It produces life‐saving drugs belonging to all major therapeutic groups at a fraction of prices existing in the world market and thus, has been seen as ensuring health security of the poorer countries. The Annual Report of the Department of Chemicals and Petrochemicals, Government of India, describes it as one of the largest and most advanced among developing countries. The industry today posseses the largest number of US Food & Drug Administration (FDA) approved manufacturing facilities outside the US and has filed 110 Drug Master Files (DMFs) with the US FDA for drug exports to the US, which is higher than that filed by Spain, Italy, China and Israel taken together. Figure 17: US DMF filings – Global vs India

The phenomenal progress made by the industry over the last three decades has instilled a strong belief in the government and the pharmaceutical companies in India Page | 42

that the country has a competitive strength and it should be enhanced by suitable policy measures and firm‐specific actions with regard to export, innovation, strategic alliances and investment. The Pharmaceutical Policy 2002 echoes the same sentiment and has shifted the focus of the policy from self‐reliance in drugs manufacturing to the objective of enhancing global competitiveness. The introduction of the Policy says: “The basic objectives of Government’s Policy relating to the drugs and pharmaceutical sector were enumerated in the Drug Policy of 1986. These basic objectives still remain largely valid. However, the drug and pharmaceutical industry in the country today faces new challenges on account of liberalization of the Indian economy, the globalization of the world economy and on account of new obligations undertaken by India under the WTO Agreements. These challenges require a change in emphasis in the current pharmaceutical policy and the need for new initiatives beyond those enumerated in the Drug Policy 1986, as modified in 1994, so that policy inputs are directed more towards promoting accelerated growth of the pharmaceutical industry and towards making it more internationally competitive. The need for radically improving the policy framework for knowledge‐based industry has also been acknowledged by the Government. The Prime Minister’s Advisory Council on Trade and Industry has made important recommendations regarding knowledge‐based industry. The pharmaceutical industry has been identified as one of the most important knowledge based industries in which India has a comparative advantage.” Against the above backdrop of increasing attention of the policy makers on global competitiveness of the Indian pharmaceutical sector, let us make an attempt to put the performance of the sector in a global setting. Most of the recent studies on Indian pharma industry deal with the impact of economic liberalization and new global intellectual property rights (IPR) regime on industry performance like R&D and patenting, foreign investment, exports, and drugs prices and public health. However, the issue of global competitiveness of the industry is still not rigorously addressed. How does Indian pharma industry perform in a global setting? This issue, in turn, involves a comparative analysis of the Indian pharmaceutical industry in a cross‐ country setting and exploring its growth, productivity, technology and trade performance vis‐à‐vis global peers in the sector and an analysis of new competitive strategies that Indian firms are adopting to compete in the global market. 3.2 Evolution of Indian Pharmaceutical Industry The pharmaceutical production in India began in 1910s when private initiatives established Bengal Chemical and Pharmaceutical Works in Calcutta and Alembic Chemicals in Baroda and setting up of pharmaceutical research institutes for tropical diseases like King Institute of Preventive Medicine, Chennai (in Tamil Nadu), Central Drug Research Institute, Kasauli (in Himachal Pradesh), Pastures Institute, Coonoor (in Tamil Nadu), etc. through British initiatives. The nascent industry, however, received setbacks in the post World War II period as a result of new therapeutic developments in the Western countries that triggered natural elimination of the older drugs from the market usage by newer drugs like sulpha, antibiotics, vitamin, hormones, antihistamine, tranquilizers, psycho pharmacological substances, etc. This culminated in the discontinuation of local production based on indigenous materials and forced the industry to import bulk drugs meant for processing them into formulations and for selling in the domestic market. Page | 43

3.2.1 The Stages of Growth Figure 18: Stages of Growth of the Indian Pharmaceutical Industry

In the post‐independence period, Indian pharmaceutical industry exhibited four stages of growth. In the first stage during 1950s–60s, the industry was largely dominated by foreign enterprises and it continued to rely on imported bulk drugs notwithstanding its inclusion in the list of ‘basic industries’ for plan targeting and monitoring. Foreign firms, enjoying a strong patent protection under the Patent and Design Act 1911, were averse to local production and mostly opted for imports from home country as working of the patent. Given the inadequate capabilities of the domestic sector to start local production of bulk drugs and hesitation of foreign firms to do so, the government decided to intervene through starting public sector enterprises. This led to the establishment of the Indian Drugs and Pharmaceuticals Ltd. (IDPL) plants at Rishikesh and Hyderabad in 1961 and the Hindustan Antibiotics at Pimpri, Pune, in 1954 to manufacture penicillin. The starting of the public sector enterprises has been an important feature in the evolution of the pharmaceutical industry as it assumed initiative roles in producing bulk drugs indigenously and led to significant knowledge spillovers on the private domestic sector. The second growth stage of the industry took place in the 1970s. The enactment of the Indian Patent Act (IPA) 1970 and the New Drug Policy (NDP) 1978 during this stage are important milestones in the history of the pharmaceutical industry in India. The IPA 1970 brought in a number of radical changes in the patent regime by reducing the scope of patenting to only processes and not pharmaceutical products and also for a short period of seven years from the earlier period of 16 years. It also recognizes compulsory licensing after three years of the patent. The enactment of the process patent contributed significantly to the local technological development via adaptation, reverse engineering and new process development. As there exits several ways to Page | 44

produce a drug, domestic companies innovated cost–effective processes and flooded the domestic market with cheap but quality drugs. This led to the steady rise of the domestic firms in the market place. The NDP 1978 has increased the pressure on foreign firms to manufacture bulk drugs locally and from the basic stage possible. Foreign ownership up to 74 per cent under the Foreign Exchange Regulation Act (FERA) 1973 was permitted to only those firms producing high technology drugs. Foreign firms that are simply producing formulations based on imported bulk drugs were required to start local production from the basic stage within a two year period. Otherwise were required to reduce their foreign ownership holding to 40 per cent. New foreign investments were to be permitted only when the production involves high technology bulk drugs and formulations thereon. The outcomes of the strategic government interventions in the form of a soft patent policy and a regime of discrimination against foreign firms affected the industry with a time lag and provided strong growth impetus to the domestic sector during 1980s. In the third stage of its evolution, domestic enterprises based on large‐scale reverse engineering and process innovation achieved near self‐sufficiency in the technology and production of bulk drugs belonging to several major therapeutic groups and have developed modern manufacturing facilities for all dosage forms like tablets, capsules, liquids, orals and injectibles and so on. These had a lasting impact on the competitive position of the domestic firms in the national and international markets. In 1991, domestic firms have emerged as the main players in the market with about 70 and 80 per cent market shares in the case of bulk drugs and formulations respectively (Lanjouw, 1998). The industry turns out to be one of the most export‐oriented sectors in Indian manufacturing with more than 30 per cent of its production being exported to foreign markets. The trade deficits of the seventies have been replaced by trade surpluses during 1980s (See Table). The growth momentum unleashed by the strategic policy initiatives continued in the fourth stage of the evolution of the industry during 1990s. The production of bulk drugs and formulations have grown at very high rates and the share of bulk drugs in total production has gone up to 19 per cent in 1999–2000 from a low of 11 per cent in 1965–66. This stage has also witnessed dramatic changes in the policy regime governing the pharmaceutical industry. The licensing requirement for drugs has been abolished, 100 per cent foreign investment is permitted under automatic route, and the scope of price control has been significantly reduced. India has carried out three Amendments in March 1999, June 2002 and April 2005 on the Patent Act 1970 to bring Indian patent regime in harmony with the WTO agreement on Trade Related Intellectual Property Rights (TRIPs). The third and the final one, known as the Patents (Amendment) Act, 2005 came into force on 4th April 2005 and introduced product patents in drugs, food and chemicals sectors. The term of patenting has been increased to a 20 year period. These changes in the policy regime in the 1990s, thus, started a new chapter in the history of Indian pharmaceutical sector where free imports, foreign investment and technological superiority would determine the trade patterns and industrial performance. The Indian pharmaceutical industry is looking at this era of globalization as both an opportunity and a challenge. Table 5: India’s Trade in Pharmaceutical Products, 1970–71 to 1999–2000

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3.2.2 Comparative Analysis of the Competitive Strength of the Indian Pharmaceutical Industry Page | 46

With the arrival of global patent regime and widespread liberalization measures at the individual country, bilateral, regional and multi‐lateral levels, the issue of competitiveness is critical for understanding the strengths and weaknesses of a country in the global market place. The strategic government policies can have a long‐ term impact on the growth and structure of an industry. This view is known as the strategic trade theory in international economics. The relevance of government policy continues to be critical even in an era of liberalization and this holds for knowledge‐ based industries in developing countries. For example, the government promotion of local technological activities through fiscal or other incentives is always needed when free market forces are not capable of scaling up the developing country’s capabilities in high technology intensive industries. Once it is known where a country lacked in competitiveness vis‐à‐vis others, then the concerned government can take facilitating policy measures to address the inadequacy. In what follows, an assessment of the competitiveness of Indian pharmaceutical industry is presented. The competitive strength of an industry in the global market can be seen in several ways. One simple way is to compare the relative size and growth performance in value‐added. A stronger growth performance exhibited by a particular industry in cross country comparisons indicates rising level and strength of production, which may drive the sector to emerge as a global player. Most of the studies on cross– country and industry level comparisons of competitiveness also emphasized on the productivity level. In order to achieve a relatively higher growth performance among countries, one country in the particular sector is required to produce relatively more output per input combination over time and among competing countries. Innovation is an important source of cross–country differences in the productivity performance. This is especially true in the case of knowledge‐based industries like pharmaceuticals. Hence, a comparison of the level of innovation can also, to a certain extent, measure the competitive strength of the sector. The export market share and import coverage of the export (i.e. import to export ratio) are also important indicators of competitive strength. An industry doing very well in the international market suggests that it is scaling up its supplier position vis‐à‐vis other competitors and in fact possesses a strong comparative advantage in the product. The present section looks into the trends in above mentioned indicators to examine the global competitive strength of the Indian pharmaceutical industry. 3.2.3 Growth and Relative Size The Table below provides a picture of growth performance among eighteen selected countries in the pharmaceutical sector since late 1970s. The growth rate of global pharmaceutical value‐added has consecutively slowed down and has fallen from an estimated rate of 25 per cent in 1980–85 to 18.74 per cent in 1990–95 and further to 15.8 per cent in 1995–2000.

Table 6: Growth of Pharm Industry in India vis-à-vis in other countries, 1975–2000, PPP $

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Source: Central Statistical Organization Given the absence of blockbuster innovations in the last two decades, it is logical to expect a downward trend in the growth performance of the technology‐driven pharmaceutical sector. Contrary to the slow‐down of the global trends, Indian pharmaceutical sector turns out to be one of the fastest growing industries in the global market place. In 1980–85, there are ten countries surpassing India’s growth performance, which has fallen to only three countries in 1985–90 and just two in 1990–2000. It has grown at a phenomenal rate of 41 and 28 per cent per year during 1990–95 and 1995–00 respectively, standing as the third largest growing pharmaceutical industry amongst the selected countries. The rapid rise of India in the late 1980s can be partly attributed to the suitable policy measures including a soft patent regime that the Indian government adopted during 1970s and partly to the growth of generic segment in world pharmaceutical market following the off‐ patenting of a number of drugs in the late 1990s. The off‐patenting phenomenon helped many Indian firms enter the generic‐space of international market with their own cost‐effective processes and the rise of a few Indian companies like Ranbaxy, Dr Reddy and Cipla to market their own formulations after obtaining US‐FDA approval. As a result of the consistently higher growth performance in the last two decades, the size of Indian pharmaceutical industry has increased impressively with significant gains in the share of world pharmaceutical value‐added. India’s share of value‐added nearly doubled between 1980 and 2000, from 3.79 per cent to become 7.11 per cent. The size of Indian pharmaceutical industry is estimated to be about PPP $ 11508 million in 2000, which is about 43 times the size of Austria, 36 times the size of Norway and 10 times the size of Australia! It is even larger than the combined size Page | 48

of Austria, Belgium, Canada, Denmark, Finland, Netherlands and Norway! The size of the Indian pharmaceutical industry would have been even much larger since the unorganized segment of the industry has not been taken into account in the study. Therefore, Indian pharmaceutical industry has achieved a high level of growth performance and a scale that is comparable to the global peers. Figure 19: Size of Indian Pharma Industry and its share in global pharmaceutical value added

Source: Based on Table 6

3.2.4 Productivity The relatively rapid growth of output may not be sufficient to ensure competitiveness of a country in the long run unless there is sustained increase in the efficiency with which resources are employed in value‐added activity. Productivity is a key determinant of competitiveness, especially in a technology‐intensive industry like pharmaceuticals. Those countries that produce increased value‐added per unit of inputs overtime vis‐à‐vis other countries are sure to perform better in the international market. The Indian pharmaceutical sector has experienced high rates of productivity growth in 1990s as compared to its performance in 1980s. In the year 2000, the industry generated about PPP $49242 of value‐added per unit of labour, which is more than four‐times the value added generation in the year 1980 (PPP $10660). How did the Indian pharmaceutical sector perform as compared to others in terms of productivity? It appears that relative productivity of Indian pharmaceutical sector is one of the lowest in the world and continued to be so between 1980 and 2000. The series on relative labour productivity presented in Table 7 suggests that for each PPP $100 of Page | 49

the value‐added that USA generated per person employed in 1980, India could generate only about PPP $26. The relative productivity of India in relation to the US has fallen to PPP $19 in 1985 and remained stagnant between 1990 and 1995, ahead of an improvement to reach PPP $23 in 2000. This shows that India’s impressive growth in value‐added as observed in the previous sub‐section is not accompanied by a commensurate rise in the level of relative productivity in terms of the cross–country analysis. The fragmented nature of Indian pharmaceutical sector characterized by the operation of a very large number of players, estimated to be about 10,000 units of which just 300 units are medium and large‐sized, may be a reason for low level of productivity. The other important factor for low productivity can be due to the nature of technological activities in the sector, which tends to rely more on process than product development. Further, it may be that Indian companies are focusing at the low end of value‐chains in the pharmaceuticals like producing generics than opting for branded products or supply bulk drugs to global players than market formulations of their own. This low productivity performance of India in comparison to global peers suggests that the country has to improve the quality of innovation, scale and focus on high value added segment of pharmaceutical production. Addressing these factors is very important for enhancing India’s global competitiveness. It should be mentioned that low labour productivity of India as compared to the US does not necessarily reflect that India is sliding on the path of global competition since higher value addition in the US reflect higher compensation to labour and capital in the form of higher wages to skilled labour and charging higher profit margins and taxes on capital. In India, domestic companies are known to have lower profit margin because of charging lower prices for drugs and Indian skilled manpower works at much lower wages than what their counterparts get in the US. Table 7: Labour Productivity in Pharmaceutical Industry, PPP $

Source: Central Statistical Organization, Annual Surveys of Industries.

3.2.5 Innovation Several studies on the economics of technological change and technology gap approach to international trade have brought out that growth performance and Page | 50

competitive advantages of countries go together with their activities of technological innovation and imitation. They have shown that technological development measured by patent and R&D expenditures have significant impact on the trade performance of the countries. The pharmaceutical industry being one of the most technology‐intensive industries, the extent and nature of innovation is crucial for countries to prolong their productivity growth and competitiveness in the long run. In broad terms the process of technological change can occur through improvements in the products, production process, raw material and intermediate inputs, and through enhancements in the efficiency of the management system. Indian domestic pharmaceutical companies are known for their innovative cost‐effective processes, discovery in novel drugs delivery system, self‐reliance in producing quality raw materials and production led by quality management. However, these technological strengths are confined to a few large Indian pharmaceutical companies. As the Indian industry is dominated by a large number of companies, both medium and small‐sized, the research activities in the sector are quite limited and inadequately focused on development of new drugs. Majority of the Indian companies suffered from limitation of financial, technical and skill resources to undertake any kind of R&D activities. A recent study found that in a sample of 223 firms, about 62.3 per cent of firms are not engaged in innovative activities and another 21.1 per cent firms undertake R&D, which is even less than 1 per cent of their sales in the year 1999–2000. Using R&D as an indicator of technological activities, Table 8 presents the growth rates of pharmaceutical R&D in selected countries. It can be seen that India had consistently pushed up its pharmaceutical R&D expenses since 1987. The Indian pharmaceutical R&D has grown by 17 per cent during the period 1987–91. The growth rate has gone up to 26 and 83 per cent over the periods 1992–96 and 1997– 2001 respectively. This high growth rate of India in pharmaceutical R&D seems to be due to the low base of pharmaceutical R&D in the base years. In the period 1997– 2001, India turned out to be second highest R&D growing pharmaceutical sector among the selected countries. Moreover, India’s R&D relative to the US is also observed to be increasing. For each PPP $100 worth of R&D expenditure incurred by the US pharmaceutical sector in 1990, Indian pharmaceutical sector had incurred just PPP $2 and 40 cents. The relative R&D spending of India in terms of the US spending has gone up to PPP $4 and 80 cents in 2000. Although, there is a vast gap in the amount of pharmaceutical R&D expenses undertaken by the US and India, the relative gap in R&D spending is falling modestly over the years. The growing trends of R&D expenses may be a good sign but not a sufficient condition to ensure a rising competitiveness for Indian pharmaceutical sector. Unless the sector sets aside an increasing proportion of its value‐added for the R&D activities over time and across countries, expanding global position would be difficult. The R&D intensities, the percentage of the value‐added devoted for the R&D activities, for a group of countries is furnished in Table 9. Two important points can be deduced from it. First, Indian pharmaceutical industry as compared to global peers incurs a very small fraction of its value‐added for research and innovative activities. In 1990, its R&D spending is not even one per cent of the value‐added and is the lowest in the cross‐ country comparison. Second, Indian pharmaceutical industry has significantly improved its R&D intensity in the 1990s. Between 1990 and 2000, its R&D intensity has increased by more than nine times from 0.91 per cent to 8.7 per cent. In 2000, the R&D intensity of India is higher than that of Korea, Italy and matches that of Spain. Page | 51

Table 8: Growth of Pharmaceutical R&D, PPP $

Source: OECD R & D Expenditure in Industry database, 1987-2001 Table 9: Pharmaceutical R&D Intensity (%), 1987–2000, PPP $

Source: OECD, STAN Database 2004 3.2.6 Trade Performance Table 10 and figure 20 show the pharmaceutical exports of India and its growth rates over the periods 1990–94, 1995–99 and 2000–04. It can be observed that India has increased its pharmaceutical exports at a rapid pace in the 1990s. The total Page | 52

pharmaceutical exports in 2004 stood at US $2.2 billion, nearly five times the figure pertaining to 1990. The exports have consecutively achieved higher growth rates, 14 per cent in 1990–94, 23 per cent in 1995–99 and 44 per cent in 2000–04. In relation to a group of selected twenty‐nine countries, India is much ahead of fifteen countries in terms of growth performance in pharmaceutical exports during 2000–04. India’s 44 per cent growth rate is higher than that of the US, China, Italy, Indonesia, Malaysia, Mexico, Brazil, Rep. of Korea, Portugal, Japan, Thailand, South Africa, Argentina, Singapore and Hong Kong. However, irrespective of its impressive export growth rates, India’s share in the global pharmaceutical exports has not shown any improvement. In fact, it is hovering around 1 per cent of market share. India’s recent export growth rate has not yet translated into gains in export share as India’s growth performance is much lower when compared to the 60 per cent growth rate of world pharmaceutical exports during 2000–2004 and also its contribution to the global sum is minimal. Figure 20: India’s Performance in Pharmaceutical Exports, in $ mn and per cent

Although, India is far from significantly increasing its global export share, it belongs to the selected group of eight countries, which have consistently enjoyed favourable trade balance in pharmaceuticals, i.e. exporting more than the amount being imported, during 1990–2004 (Table 10). These countries are Switzerland, Germany, UK, France, Sweden, Denmark, India and China. India’s trade surplus in the pharmaceutical product has increased by eight‐times between 1990 and 2004 from a low of US $195 million to $1616 million. As a consequence of rising trade balance, the export to import ratio has increased from 1.75 in 1990 to 3.4 in 2004. Table 10: Trade Balance in Pharmaceuticals

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Source: Based on the UN COMTRADE Database, 2006.

3.2.7 New Global Strategies of the Indian Pharmaceutical Enterprises Competitive advantages of the Indian pharmaceutical industry also critically hinges upon the types of global strategies adopted by its firms. Internationalization strategy that tends to complement and upgrade the technological strength of Indian pharmaceutical companies can be very crucial for sustaining and enhancing their competitive position in the world market. For example, as large number of Indian pharmaceutical firms lack technological capabilities for product development, acquiring overseas business enterprises with new product portfolios, technology and skills can allow them to emerge as global players. Internationalization in the form of strategic collaborations with global pharmaceutical companies from developed countries for contract manufacturing, research and marketing can also be beneficial for Indian companies to expand their global operations. In the last decade, the business strategies of Indian pharmaceutical companies with respect to the overseas market have undergone significant changes. Their business decisions are increasingly driven by global market orientation for their products, business location and sourcing of raw materials and intermediates inputs. After identifying strategic markets across the globe, they adopted a variety of global strategies for enhancing their market position like undertaking direct investment for Greenfield projects and overseas acquisitions, tapping foreign securities and capital markets, entering into contract Page | 54

manufacturing with global players, strategic alliances, apart from the traditional method of exporting. Various segments of value‐added activities of Indian pharmaceutical firms like manufacturing, distribution and marketing, R&D, are now being coordinated and formulated according to considerations of global geographical advantages and worldwide business environment. In this section we look at these global strategies that the Indian pharmaceutical companies have adopted to expand their operations globally. Outward Greenfield Foreign Direct Investment A growing number of Indian pharmaceutical firms are undertaking outward FDI to diversify their business overseas. The number of joint and wholly‐owned ventures undertaken by Indian pharmaceutical companies has consistently increased from just 1 in 1990 to a peak of 31 in 1997 (Table 11). Between 1990 and 2000 their total numbers stood at 165 joint and wholly‐owned overseas ventures involving about $243 million. The number of outward investing firms has increased from 1 in 1990 to 11 in 1995 to 14 in 2000. A total of 52 pharmaceutical firms are observed to have been engaged in overseas green field investment activities during 1990–2000. It is interesting to note that outward FDI activity of Indian pharmaceutical industry is not entirely confined to the large‐sized firms alone. Rather a number of medium‐sized firms like Parenteral Drugs, Ace Laboratories, Max India, Claries Life Sciences, Gufic Ltd., etc., are also active in such overseas investment activity. However, the top fifteen largest outward investors from Indian pharmaceutical industry are large‐sized pharmaceutical companies. Geographically, developing countries are the major host of outward investments accounting for 55.2 per cent of the total number of outward FDI projects during the period 1990–2000. Developed countries claimed about 37.6 per cent and Central and Eastern Europe countries a share of 7.3 per cent. Table 11: Wholly‐owned and Joint‐ventures by Indian pharma companies abroad, 1990-2000

Note: * Total number of firms that have undertaken O‐FDI at least once between 1990 and March 2001. Source: i. Indian Investment Centre (1998) Indian Joint Ventures & Wholly owned Subsidiaries Abroad Approved during the year 1996, New Delhi; ii. Indian Investment Centre (1998) Indian Joint Ventures & Wholly owned Subsidiaries Abroad Approved up‐to December 1995, New Delhi;

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iii. Unpublished firm level outward investment data collected from the Ministry of Finance through Research and Information System (2002), New Delhi. WOCKHARDT LIMITED It turns out to be one of the aggressive outward investors among the Indian pharmaceutical firms. It has identified generics and bio‐generics as important future growth strategies and has adopted outward investment in greenfield and brownfield forms to achieve them. The company, at the end of 2004, made its presence felt in the leading and emerging markets of the world via its seven subsidiaries (Table 12). In 2004, more than 50 per cent of the consolidated sales of the company came from overseas markets, namely the USA and Western European markets. The consolidated sales from these markets have increased by more than 55 per cent to Rs. 6239 million in the year 2004 from Rs. 1426 million in the year 20038. The European operation of the company is undertaken by Wockhardt UK Ltd. in the UK and esparma GmbH in Germany—both are wholly‐owned subsidiaries. Wockhardt UK Ltd is the integrated and synergized entity of the two UK‐based companies, Wallis Laboratory and CP Pharmaceuticals, which were acquired by Wockhardt in 1998 and 2003 respectively. It is amongst the 10 largest generics companies in the UK and has US FDA‐approved manufacturing facilities for injectables such as cartridges, vials and ampoules (including lyophilized products). Wockhardt has adopted the same inorganic route to enter into Germany, the second largest generics market in Europe after the UK. It had acquired esparma GmbH in the year 2004 and gained a strategic and strong presence in the high potential therapeutic segments of urology, diabetology and neurology. The establishment of Wockardt USA Inc. is helping the company to strengthen its marketing networks in the US, apart from support for ANDA filings with a full fledged regulatory team. Table 12: List of Subsidiaries of Wockhardt Limited

Source: Wockardt Annual Report 2004. SUN PHARMACEUTICALS It is one of the top 5 pharmaceutical companies in India with strong manufacturing focus on speciality bulk actives of over 90 bulk drugs including ornidazole, iopamidol and iohexol and formulations. Its manufacturing facilities at four plants have US and European approvals for compliance with international good manufacturing practices, safety and quality. Like many other Indian pharmaceutical firms, overseas investment has been a key strategy for Sun Pharmaceuticalʹs drive for internationalization. Apart from exporting, the company has gone for overseas acquisition, greenfield investment and joint ventures to serve the international market. It has eight subsidiaries catering to the different regions of the international market (Table 13). Caraco Pharmaceutical Page | 56

Laboratories provided a presence of the company in high value generic markets in the US. Subsidiaries in Brazil and Mexico have recently been started to strengthen the company’s presence in the Latin American markets, besides commissioning a manufacturing facility in Bangladesh. Since 1996, the company has used overseas acquisitions to gain access to markets and manufacturing capabilities. It had acquired about 30 per cent equity in Detroit‐based Caraco Pharm Labs in 1997 and Hungarybased Valeant Pharmaʹs manufacturing operation in 2005, apart from several brand acquisitions. International sales account for about 28 per cent of the company’s total sales in 2005 (Table 15). Between 2004 and 2005, the international sales of the company have grown twice the growth rate of the domestic sales, suggesting increasing internationalization of the company. In this process of internationalization, overseas subsidiaries have played an important role. For example, the US sales of the company are increasingly driven by its subsidiary, Caraco Pharmaceutical Labs: “Increasing US sales at our subsidiary, Caraco, building on the advantage of backward integration, have helped it compete more aggressively in the competitive US generic market.” (Sun Pharmaceutical Annual Report, 2004–05, pp 2) Table 13: List of Subsidiaries of Sun Pharmaceutical Industries Ltd.

Table14: Consolidated sales of Sun Pharma and Subsidiaries, Rs million

Source: Sun Pharmaceutical Annual Report, 2004–2005, pp. 2.


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Gujarat‐based Core Healthcare Limited (CHL), leading manufacturers of intravenous (IV) fluids, has planned an aggressive entry into international markets. It is supplying products to more than 70 countries, exporting more than 35 per cent of the total production. In 2002, the production of intravenous (IV) fluid reached the one billion mark and the company had attributed this achievement to its international operations, distribution network and quality of products. It is the first Indian pharmaceutical company to receive the ISO certification. The company has about 600 outlets across the country and has a 40 per cent market share in IV business. Maintaining highest levels of quality and resorting to joint ventures with overseas strategic partners has been crucial for higher export performance. In 1997, the company has set up a joint venture with Uzpharmprom in Uzbekistan for manufacturing IV fluids and tablets. In 1999, the company established two manufacturing plants for IV fluids, tablets and penicillin capsules in Myanmar and Malaysia. The Myanmar plant is build for Government of Myanmar at the cost of $5 million, located near Yangon. It provides the most modern healthcare facilities like high quality I.V. fluids and other pharmaceutical products in Myanmar. However, despite maintaining growth and emphasizing on internationalization, the company could not improve its economic performance. The financial strength of the company was severely hurt due to delayed and high‐cost of financing since 1996 and internal resources were not enough for meeting the high growth plan adopted by the company and also partly due to management concerns. As a result, the company emerged as one of the biggest bank defaulters companies and has been referred to the Board of Industrial and Financial Reconstruction (BIFR) in March 2000 to be declared as a sick unit. In December 2004, the company with its assets and liabilities was acquired by another company named Nirma Ltd. AJANTA PHARMACEUTICAL Ajanta Pharmaceutical is another Indian company that has adopted outward investment as a strategy to improve its position in international markets. It has some eight transborder subsidiaries and joint ventures (Table 15). Geographically, majority of these outward ventures are directed at the CIS (Commonwealth of Independent States) markets such as Kazakhstan, Tajikistan, Uzbekistan and Kyrgyz Republic. Subsidiaries in two countries such as Mauritius and Turkmenistan have world‐class manufacturing facilities with state‐of‐the‐art infrastructure to manufacture various dosage forms like tablets, capsules, injections, ointments and powders. These are two subsidiaries that are performing well with profits and are expected to improve their performance substantially. However, other overseas ventures such as Ajanta Pharma (Tashkent), Tajik Ajanta Pharma, Kazakh Ajanta Pharma, Surkhan Ajanta Pharma and Kyrgyz Ajanta Pharma have turned out to be non‐performing ventures and the company is in the process of exiting from all of them. The company realized that outward FDI meant for producing in the foreign markets may not always be a profitable option of market serving. Rather outward FDI in the form of opening own marketing offices and trade supporting networks that ensure prompt delivery and follow‐up programs is helpful for exporting from the home country. The company with a view to expand overseas business operations has established an extensive marketing network in foreign markets. This has helped the company to access the international markets extensively and presently it exports to over 50 countries around the world with exports accounting a substantial part of the total revenues. In 2004–05 exports constituted about 80 % of the sales as compared to 72 per cent in 2003–04. Page | 58

Table 15: Subsidiaries and Joint Ventures of Ajanta Pharmaceutical

Source: Ajanta Pharma Annual Report 2003–04. STRIDES ARCOLAB LIMITED This company provides an example of a very young pharmaceutical company successfully expanding business in international market. Since its beginning in 1990 as a small pharmaceutical company engaged in formulations, Strides Arcolab has grown to be a Rs. 500 crore company and among top 15 pharmaceutical companies in India. Its manufacturing activities now cover a spectrum of ethical pharmaceutical products, OTC products and nutraceuticals. It is one of the top five softgel capsule manufacturers in the world with twelve internationally approved manufacturing plants in USA, Mexico, Brazil and India. The company has established strong marketing capabilities overseas with marketing presence in 49 countries. As a result of the trade‐ supporting type of FDI that the company has undertaken in the past, a substantial part of its revenue is contributed by exports. During 2004–05, exports accounted for about 92 per cent of sales of the company. Apart from undertaking exports and marketing activities, the company has strongly gone for direct production overseas. It has about twelve overseas subsidiaries across the world (Table 17) and about 95 per cent of its global revenues is contributed by foreign markets (Table 16). This indicates that Strides is largely a multinational firm with business strategies and planning is more focused on global markets.

Table 16: Geography of Strides Arcolab’ Revenues, 2002–03 to 2003–04

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Source: Based on Strides Arcolab Annual Report 2003–04, pp 1.8. Table 17: Subsidiaries and Joint Ventures of Strides Arcolab

Source: Strides Arcolab Annual Report 2003–04 There are several other Indian pharmaceutical firms such as Dabur, Dr. Reddy, Natco Pharma, and others who have pursued the strategy of greenfield outward investment to expand business globally. As growing number of firms are undertaking this route of Page | 60

globalization, this indicates that Indian pharmaceutical companies are more global now than ever before. Brownfield Overseas Investment Last ten years or so have seen Indian pharmaceutical firms progressively adopting brownfield investment as an alternative strategy for trans�border growth through acquisitions of business enterprises abroad. The number of investments for overseas acquisitions increased significantly from just 1 in 1995 to 21 in 2005 (Table 18). Between 1997 and 2005, the amount of consideration involved in overseas acquisitions has increased by 71 times from just $7.5 million to reach $532.9 million. At the end of March 2006, Indian pharmaceutical companies have undertaken $1663 million worth of investments in acquiring overseas pharmaceutical companies, brands and R&D laboratories. Most of these acquisitions, nearly 76 per cent of the overseas acquisition cases, are directed at developed markets like Europe and North America. Developing countries accounted for just about 18 per cent and Central and Eastern Europe about 5.6 per cent. This shows that overseas acquisition activities of Indian pharma companies are largely developed market oriented and apart from being as market entry strategy, such activities are motivated to acquire foreign research capabilities, skills and intellectual properties. Table 18: Overseas Acquisitions by Indian Pharmaceutical Companies, 1995 to March 2006

Note: In calculating amount of consideration only those acquisition deals are included for whom information on consideration is available.

Table 19: Overseas Acquisitions by Indian Pharmaceutical Companies, 1995 to March 2006

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Page | 64 RANBAXY LABORATORIES Ranbaxy emerged as the largest overseas acquirer with 11 acquisitions during 1995– 2006 (Table 19). In September 1995, the company acquired Ohm Laboratories based in New Brunswick, New Jersey. This is an important strategy since the company entered the US market in 1994. This acquisition provided Ranbaxy’s access to advanced manufacturing capabilities and processes to manufacture quality OTC (over-the‐counter) drugs, branded and generic products and helped in developing its presence in the US OTC market. In April 2000, the company acquired Basics GmbH, the generics business of Bayer in Germany for a consideration of $4 million. Apart from Ranbaxy’s entry into the third largest generics market of the globe, the deal has expanded its product portfolio by another twenty products hitherto marketed under Basics. The year 2002 saw three overseas acquisitions by Ranbaxy. It has acquired Veratide, an antihypertensive brand from Procter & Gamble Pharmaceuticals in Germany. This brand acquisition is to further strengthen Ranbaxy’s presence in the German market by augmenting Basics’ cardiovascular product portfolio. The second acquisition in the year 2002 is liquid manufacturing facility from the New York‐based Signature Pharmaceuticals Inc. This manufacturing facility with its latest testing, research and quality assurance capabilities is a strategic fit for Ranbaxy’s business in the US for the production of certain liquid‐based dosage forms. The third acquisition in the year 2002 is that of acquiring 10 per cent equity stake in a generic company named Nihon Pharmaceutical Ltd in Japan. As a part of this acquisition, Ranbaxy and Nippon Chemiphar Limited (NC), the parent company of Nihon Pharmaceutical, entered into a strategic alliance to launch Ranbaxyʹs ethical and drug delivery system based products, besides generics in the Japanese market. In December 2003, Ranbaxy acquired France’s fifth largest generic player, RPG Aventis and its subsidiary, OPIH SARL, for $86 million20. This acquisition, a move by the company to expand its European position through France, has placed it amongst the top generic companies in the French market. It also added to Ranbaxy’s product portfolio by another 52 molecules of which 18 are among the 20 best selling molecules in the French market. With the dual purpose of securing presence and augmenting existing product portfolio in Spain, Ranbaxy has acquired a generic product portfolio covering eighteen products from the Spanish pharmaceutical company Efarmes, SA. This acquisition has helped the company to significantly improve its ability to provide a wide range of quality generics belonging to the cardio vascular system (CVS), central nervous system (CNS) and pain management segments. In March 2006, Ranbaxy announced four overseas acquisitions, namely patents for autoinjector device of Senetek, unbranded generic business of Allen SpA, Terapia and Ethimed NV. The first overseas acquisition is a strategy of acquiring firm‐specific intangible assets for autoinjector business. Ranbaxy acquired patents, trademarks and equipment used for the self‐administration of medicines from the US company Senetek. The second one concerns with the company’s entry strategy into the Italian generic market. The acquisition of unbranded generic business of Allen SpA, a division of Page | 65

GlaxoSmithKline, ensures Ranbaxy’s access to the Italian market, one of the fastest growing markets in Europe. The third acquisition involved the two low cost manufacturing capacities of Terapia, which would allow Ranbaxy to leverage its new found production base in the Romanian pharmaceutical market to strengthen its presence in the European Union and the CIS markets. As a part of this deal, Ranbaxy’s product portfolio has been expanded by Terapia’s product basket of 157 marketing authorisations with a strong focus on the fast growing CVS, CNS & musculoskeletal therapeutic segments. The fourth acquisition is in continuation of the company’s strategy to strengthen its global position in the generic market. The acquisition of Ethimed, among top ten Belgium generics companies, would provide a strong manufacturing and marketing base for Ranbaxy to expand business operations in the Benelux countries. GLENMARK PHARMACEUTICALS Glenmark Pharmaceuticals emerged as the second aggressive overseas acquirers from Indian pharmaceutical industry with five overseas acquisitions each. Of the five acquisitions done by Glenmark Pharmaceuticals, two are brand acquisitions and other three involve acquisition of manufacturing/marketing companies. In April 2004, Glenmark acquired a Brazilian firm, Laboratorios Klinger, for $5.2 million. The acquired entity has manpower of 176 employees and 91 sales representatives, besides one manufacturing facility. With 21 approved product registrations in Brazil, this acquisition would provide Glenmark an existing presence in branded generics and over‐the‐counter (OTC) drugs segment of the Brazilian market. The company acquired two FDA approved products from Clonmel Healthcare Ltd. In August 2004, and the hormonal brand, Uno‐Ciclo, from Instituto Biochimico Indústria Farmacêutica Ltda for $4.6 million in March 2005. With a plan to expand business in the Argentine pharmaceutical market, Glenmark has acquired a marketing company Servycal SA engaged in cancer‐related products. The acquired company has a strong retail and hospital presence in Argentina and apart from Argentina, its products are registered in 12 other countries in South America. In December 2005, Glenmark acquired Bouwer Bartlett, a South African sales and marketing company, for gaining entry into the South African market, which is one of the largest and fastest growing pharmaceutical markets in Africa. The acquired entity currently has a basket of 22 products mostly covering the dermatology segment and this acquisition would help the long‐term strategy of Glenmark to emerge as a company having its own marketing channels for drugs. SUN PHARMACEUTICAL Sun Pharmaceutical has undertaken five overseas acquisitions between 1997 and 2006 (Table 19). To enter the lucrative US generic markets, it has acquired about 30 per cent equity stakes in Detroit‐based Caraco Pharm Labs in 1997. The acquired company is engaged in manufacturing and marketing of generic‐drugs. Subsequently additional stakes were obtained in 2002 and 2004, to increase the total holding to about 63.14 per cent. Initially, this US strategy seems to have been costly for Sun Pharmaceutical as Caraco generated large losses as compared to revenues. In 1999, its loss was $9.3 million as compared to $2.89 million sales. The development expenses incurred by Caraco to get Sunʹs generic drugs into the US market constitute a substantial part of this loss. However, twenty‐four months later, this US story was a bigger success. Caraco’s sales grew by 24 per cent, owing to Sun’s products during the first half of 2005–06, double Page | 66

the growth rate of the US generics market. This is impressive since the market is witnessing severe price erosion and the sales of other Indian players in the US like Ranbaxy and Dr Reddy’s has fallen sharply. In September 2004, Sun Pharmaceutical purchased three brands belonging to synthetic anti‐bacterial Bactrim, gynaecological Ortho‐Est and the anti‐migraine preparation Midrin, from US‐based Womenʹs First Healthcare for about $5.4 million. In the same month, it has also bought a dosage form plant at Bryan, Ohio. As a part of its strategy to enter the European generic market, the company bought Valeant Pharma’s Hungarian manufacturing facilities in August 2005. In November 2005, Sun Pharma acquired the dosage form manufacturing operations of the US‐based Able Laboratories for $23.15 million. The deal also includes intellectual property for 40 product portfolio being marketed by Able. These acquisition strategies of manufacturing plants, brands and intellectual properties have helped the company to quickly establish its presence in the new market, move into new areas and boost its global operation. OTHERS The next group of aggressive overseas acquirers includes three Indian Pharmaceutical firms, namely Dr Reddyʹs Laboratories, Jubilant Organosys and Stides Arcolab with four acquisitions each (Table 19). Aurobindo Pharma, Nicholas Piramal India and Wockhardt, with three acquisitions, have emerged as other important overseas acquirers. Dishman Pharmaceuticals and Matrix Laboratories have undertaken two overseas acquisitions while other firms like Kemwell, Malladi Drugs, Marksans Pharma, Natco Pharma, Suven pharmaceuticals, Torrent Pharmaceuticals, Unichem and Zydus Cadila have one overases acquisition each. This suggests that Indian pharmaceutical firms are aggressively pursuing mergers and acquisitions route to become global players by acquiring new technology, brands and production capabilities abroad. Contract Manufacturing and Strategic Alliances Contract Research In 2002, the industry for clinical trials in India was $ 70 million. This market is growing at a rate of 20% per annum. According to experts, it will be an industry worth anywhere between $500 million to $1.5 billion by 2010. The global R&D spend is to the tune of $60 billion, of which the non-clinical segment accounts for $21bn and the clinical segment accounts for $39bn. In terms of Indian prices, this translates into $7bn (at 1/3rd of US/EU costs) and $7.8 bn (at 1/5th of US/EU costs) repectively. This constitutes a total potential of $14.8bn for the Indian pharma companies. Contract manufacturing Many global pharmaceutical majors are looking to outsource manufacturing from Indian companies, which enjoy much lower costs (both capital and recurring) than their western counterparts. Many Indian companies have made their plants cGMP compliant and India is also having the largest number of USFDA-approved plants outside USA. The Pharma companies are going for compliance with International regulatory agencies like USFDA, MCC etc. for their manufacturing facilities. Very recently contract manufacturing emerged as a new growth strategy for many Indian pharmaceutical companies, besides offering contract services like marketing, research, clinical trials, data management and laboratory services to global Page | 67

pharmaceutical companies. The process of outsourcing brings substantial economic gains to large global firms as they contract the production of their products to those who can work cost effectively and qualitatively and thus relieve them to focus on their core competencies and high value‐added operations like research and marketing. Indian pharmaceutical companies with their low cost manufacturing capabilities meeting international regulatory standards, expertise in process research and easy availability of qualified workforce in India are better placed globally to get real boost from this global trend of outsourcing. For Indian firms, outsourcing and strategic alliances not only provide additional sources of revenues, but also access to new technologies, marketing networks and best business practices abroad. A large number of Indian companies diversified into the business of contract manufacturing in the 1990s. A few names can be mentioned like Ranbaxy Laboratories, Lupin Labs, Nicholas Piramal, Dishman Pharmaceutical, Diviʹs Laboratories, Matrix Laboratories, Shasun Chemicals and Jubilant Organosys. Ranbaxy Laboratories was one of the first Indian companies to adopt the strategy of contract manufacturing, licensing and collaborative research to strengthen its competitive strength in India and overseas markets. It entered into a joint venture with Eli Lilly of USA in 1992 to market selected Lilly products in India and in 1993 Eli Lilly started sourcing Cefaclor intermediates from Ranbaxy. In 2002 Ranbaxy entered into two overseas agreements for reverse outsourcing. In June 2002, Schwarz Pharma AG of Germany announced a licensing deal with Ranbaxy to acquire the exclusive rights of developing, marketing and distributing Ranbaxyʹs New Chemical Entity RBx‐2258 for the treatment of Benign Prostate Hyperplasia in USA, Japan and Europe. As per the agreement Ranbaxy would manufacture and supply finished formulations of the product to Schwarz Pharma. Adcock Ingram formed a joint venture with Ranbaxy to obtain exclusive selling and distributing rights of Ranbaxyʹs range of anti‐retroviral products in South Africa. In February 2002, Ranbaxy Laboratories concluded an agreement with Penwest Pharmaceuticals of USA to get exclusive marketing rights of Nifedipine XL in selected markets such as China, Malaysia, Singapore, Thailand, Philippines, South Africa, and Sri Lanka and non‐exclusive rights in Mexico. The agreement also provides for joint development of other controlled release products. In July 2003, Ranbaxy Laboratories announced a strategic marketing alliance with Mallinckrodt Baker Inc (MBI), USA, to market MBI JT Baker and Mallinckrodtʹs range of scientific laboratory products in the Indian market. A collaborative research agreement was reached between Ranbaxy and ‘Medicines for Malaria Venture’ (MMV) of Geneva to develop anti‐malarial drugs in May 2003. Another collaborative research agreement with GlaxoSmithKline of UK for new drug discovery and development of new chemical entities for selected therapeutic groups using GSKʹs portfolio of patented molecules was reached in October 2003. In June 2004 Ranbaxy obtained an exclusive licensing agreement from Atrix Laboratories to develop and commercialize the latter’s product, Eligard® (leuprolide acetate for injectable suspension), in India. Starting with the experience of contract supplying a key intermediate for the tuberculostatic ethambutol for American Cyanamid, Lupin Laboratories is also an early player into the business of contract manufacturing and alliances. In February Page | 68

2004, Lupin entered into an agreement with Baxter Healthcare Corporation of the USA, whereby the latter will exclusively distribute Lupin’s generic version of ceftriaxone sterile vials for injection in the USA market. In another agreement in the same year with Allergan Inc of the US, Lupin will promote ZymarTM (gatifloxacin ophthalmic solution) in the US pediatric specialty segment. In February 2006, Lupin entered into a joint venture agreement with Aspen Pharmacare Holdings of South Africa for the development, manufacture and global marketing (except US, South Africa & India) of selected Anti‐TB products. This joint venture is motivated to derive synergies from Lupin’s strengths in Anti‐TB formulations and Active Pharmaceutical Ingredients and Aspen’s a range of MDR‐TB products. In March 2006, in a marketing agreement with Chester Valley Pharmaceuticals, Lupin will promote Atopiclair™ Nonsteroidal Cream to paediatricians in the US. These cases show that Indian pharmaceutical firms like Lupin with their extensive sales networks and sales force in the overseas markets are entering into marketing agreements with global firms to market the latter’s products. Nicholas Piramal India is among the leaders in the contract‐research and manufacturing providers from the Indian pharmaceutical industry. The company’s strategies of not infringing upon the intellectual property rights of its customers and competitors and of not entering into the lucrative overseas generic markets, led to its emergence as a strong outsourcing partner for the global innovating firms based in the developed markets. In December 2003, Nicholas Piramal got a five‐year outsourcing deal from Advanced Medical Optics Inc. of the US. As per the deal, Nicholas Piramal will supply the opthalmic products to the American company for developed markets like the US, Europe and Japan. Additional annual revenue in the range of around $ 15–25 million is expected from this contract manufacturing arrangement. In the same year the company entered into an agreement with the US‐based Minrad for exclusive distribution and marketing of a new generation of inhalation anesthetic products. Nicholas Piramal through its distributors and marketing agents would market three products, namely Isoflurane, Enflurane and Sevoflurane in Russia, Ukraine, Nigeria, Kenya, Sudan, Syria, Jordan, Iran, Eygpt and Bangladesh. The year 2004 has seen Nicholas Piramal entering into strategic alliance with Pierre Fabre of France to exclusively sell the latterʹs dermatology‐related or skincare products in India and getting two new custom manufacturing agreements from two US drug companies, which are expected to add $30 million revenues per annum. One contract deal is from Allergan Inc of the US to whom Nicholas Piramal would supply two eye‐related, anti‐ glaucoma active pharmaceutical ingredients, namely Levobunolol and Brimonidine. In November 2005, AstraZeneca AB, Sweden, signed a development and know‐how agreement with Nicholas Piramal. As per this agreement, Nicholas Piramal is chosen as a partner in development of processes for the manufacture of intermediates, active ingredients or bulk drugs for supply to AstraZeneca. In December 2005, a long‐term contract manufacturing agreement between Pfizer International LLC and Nicholas Piramal was signed for animal health products. Under this agreement, Nicholas Piramal will develop processes for Pfizer, provide scale‐up batches for Phase trials and contract manufacture after the product is launched. A pure contract‐manufacturing player, Dishman Pharmaceuticals, signed its first contract manufacturing agreement with Solvay Pharmaceuticals of Netherlands in 2001 for production and supply of an active ingredient of an anti‐ Page | 69

hypertension drug, Teveten, still under patent. This was the first case of a patented molecule to be manufactured in India on a contract basis. The contract is for eight years with an estimated value of more than $10 million. Since then it is providing contract services to a growing number of global pharmaceutical firms including AstraZeneca, GlaxoSmithKline and Merck. In July 2005, Dishman entered into an agreement with NU SCAAN of the UK to develop and manufacture bulk actives for nutraceutical products of NU Scaan. Shasun Chemicals and Drugs is another aggressive contract manufacturer from the industry. In the third quarter that ended on December 2005, contract research and manufacturing business contributed about 12 per cent of the turnover of the company. The company, which had experience of contract manufacturing for Indian companies such as Ranbaxy Laboratories and Glenmark has expanded its focus to foreign pharmaceutical companies since 1999. It has entered into a joint venture with the US based company, Austin Chemical, in December 1999. The primary focus of the venture is on joint process development and custom manufacturing to serve multinational pharmaceutical companies operating in the regulated American market. In June 2004, it had entered into a strategic partnership with another US firm, Eastman Chemical, to collaborate on the development and manufacture of performance chemicals for the pharmaceutical industry. In May 2005, US firm Codexis and Shasun entered into a manufacturing and supply agreement under which Shashun will manufacture the intermediate for a generic drug and Codexis will market the products worldwide to the generic pharmaceutical industry. The company has other strategic partnerships for supplying ranitidine (anti‐ulcer drug) and ibuprofen (anti‐inflammatory pain reducer) to the US‐based Apotex and for anti TB drugs with Eli Lilly. The above discussed cases demonstrate that Indian pharmaceutical companies have adopted contract manufacturing as a means of expanding overseas business links and very recently this has taken the form of contract research services to big multinationals companies. This technological partnership with global players has been seen across the firms, irrespective of size differences. The most recent example of strategic technological agreement is the case of Jubilant Organosys entering into a five‐year R&D contract with Eli Lilly in January 2006. Under this agreement, Jubilant would provide a range of collaborative drug discovery services to Eli Lilly, the US‐based pharmaceuticals company. These growing numbers of R&D contracts not only acknowledge the research capabilities of Indian companies, but also provide them with technological learning to emerge as global players albeit in cooperative relationship with global companies from developed countries. To summarize, Indian companies are proving to be better at developing APIs than their competitors from target markets and that too with non-infringing processes. Indian drugs are either entering in to strategic alliances with large generic companies in the world of off-patent molecules or entering in to contract manufacturing agreements with innovator companies for supplying complex under-patent molecules. Some of the companies like Dishman Pharma, Divis Labs and Matrix Labs have been undertaking contract jobs for MNCs in the US and Europe. Even Shasun Chemicals, Strides Arcolabs, Jubilant Organosys, Orchid Pharmaceuticals and many other large Indian companies started undertaking contract manufacturing of APIs as part of their additional revenue stream. Top MNCs like Pfizer, Merck, GSK, Sanofi Aventis, Page | 70

Novartis, Teva etc. are largely depending on Indian companies for many of their APIs and intermediates. The Boston Consulting Group estimated that the contract manufacturing market for global companies in India would touch $900 million by 2010. Industry estimates suggest that the Indian companies bagged manufacturing contracts worth $75 million in 2004. Figure 21: Contract Manufacturing Service Providers Across the Service Chain

Table 20: Select Contract Manufacturing Deals in India

Page | 71 Raising Resources Abroad In 1990s, Indian pharmaceutical firms have increasingly drawn on the global avenues of financing for their growth. As increasing number of Indian firms are setting up subsidiaries abroad or going for inorganic growth through overseas acquisitions, they need to raise resources for these purposes. In true sense of internationalization, their finance‐raising activities have spilled over the national boundary. A large number of firms have raised resources abroad by issuing Foreign Currency Convertible Bonds (FCCBs) and from foreign capital markets like Luxembourg, New York, London, and Singapore by sponsoring GDRs (Global Depository Receipts) and/or ADRs (American Depository Receipts). Since Indian pharmaceutical firms already have good business record and brand image in the regulated markets, tapping the global financial markets becomes easier for them. A good number of firms including Ranbaxy Laboratories, Dr Reddyʹs Laboratories, Matrix Laboratories, Sun Pharmaceuticals, Nicholas Piramal India, Cipla, Jubilant Organosys, Strides Arcolab, Lupin, Glenmark Pharmaceuticals, Cadila Healthcare, Wockhardt Ltd, Biocon, Dishman Pharmaceuticals and Torrent Pharma have been observed to have raised resources abroad in recent years.

3.2.8 Exports Page | 72

The exports constitute almost 40% of the total production of pharmaceuticals in India. India’s pharmaceutical exports are to the tune of $3.5 bn currently, of which formulations contribute nearly 55% and the rest 45% comes from bulk drugs. The export revenue now contributes almost half of the total revenue for the top 3 pharma majors: Dr Reddy’s, Ranbaxy and Cipla. The other major exporters are Wockhardt Limited, Sun Pharmaceutical Industries Ltd and Lupin Laboratories. The formulations and exports are largely to developing nations in CIS, South East Asia, Africa, and Latin America. In the last 3 years generic exports to developed countries have picked up. Table 21: Exports of Drugs, Pharmaceuticals and fine chemicals

Table 22: Growth of pharmaceutical exports

Source: DGCIS 3.2.9 Market Segmentation Due to high level of fragmentation none of the players had a market share of more than 6 % (even the top players Cipla & Ranbaxy commands only 5.24 & 5.09 per cent market share on the basis of retail sales respectively). Figure 22: Market share of top players

3.2.10 Conclusions and Policy Options Page | 73

It has been a long journey for the Indian pharmaceutical industry from being merely an import dependent to emerge as a self‐reliant producer and later as an innovation‐ driven developing country competitor in the global market. The government of India has employed a variety of policy tools to develop the domestic pharmaceutical sector and to protect it from large multinational firms operating in and dominating the industry. The starting of public sector pharmaceutical companies for indigenous production of drugs has been the initial form of government intervention. Later, a soft patent regime was adopted since 1970, which led the domestic sector on a new technological trajectory and as a result, a technologically vibrant domestic sector with remarkable technological capabilities to develop new cost‐effective processes and new drug delivery systems has emerged. This technological growth has also been contributed partly by the progress that India achieved in building its scientific, managerial, and general skills, which are readily and cheaply available to the industry for productive purposes. These national policies, thus, have contributed to the rise of the Indian pharmaceutical industry and to make it competitive in the world markets as among the cheapest producers of drugs internationally. While the Indian policy regime has succeeded in bringing out its pharmaceutical sector as among the fastest growing in the world, but it has also created its own limitations in pushing forward its productivity and technological activities. The fragmented nature of policy that had encouraged a large number of small‐ and medium‐sized pharmaceutical firms appears to have placed a constraint on the scale of production and capabilities to further upgrade the technological strength. Due to these factors, productivity and R&D intensity of the Indian pharmaceutical industry is lowest among countries. Although, India has consistently enjoyed a favourable trade balance in pharmaceutical products, its export share is still hovering around just one per cent. The policy liberalization of the past decade or so like liberalization of foreign investment, trade and industrial policy and shift towards a strong patent regime postulated by the TRIPs at the global, regional, bilateral levels and across individual countries has opened up new competitive challenges for the Indian pharmaceutical sector. Many Indian pharmaceutical firms are adopting new internationalization strategies for meeting such challenges and achieve their goal for global growth. They are strengthening their geographical presence by starting their own subsidiaries and affiliates in different strategic overseas markets. Apart from undertaking green‐field investments, they are also aggressively acquiring overseas business enterprises, brands and research facilities. Strategic alliances with and contract manufacturing, R&D and marketing for pharmaceutical companies from developed countries are also being employed by Indian pharmaceutical companies. For financing their global expansion, Indian pharmaceutical firms have been increasingly entering into global securities and finance markets. The Indian government can take several policy measures for enhancing the nation’s competitiveness in the pharmaceutical sectors. A fragmented domestic market marked by a lower degree of domestic competition is not conducive for global competitiveness. Hence, policy measures are needed to encourage mergers and acquisitions among domestic firms to offset the scale disadvantage and to overcome the trap of low R&D intensity. Increases in average firm size through M&As until the concentration index of the Indian pharmaceutical industry rises significantly, may result in improving India’s competitive advantages in the pharmaceutical sector. Government policies that encourage overseas acquisitions by the Indian companies

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for brands, technology and market access can also be important for strengthening firms’ technological capabilities. Incentives and facilitation policies for encouraging global pharmaceutical companies to outsource their production and R&D works to Indian firms shall be put in place. Data protection, investment and tax allowances for the outsourced production and R&D works, etc can be useful policies. The provision of low cost finance for research with subsidy facilities for indigenous research activities continues to be a key to competitive strategy. 3.3 3.3.1

Competitiveness of the Indian pharmaceutical industry Post 2005 scenario

By issuing the patent ordinance, India met a WTO commitment to recognize foreign product patents from January 1, 2005, the culmination of a 10-year process. In this new scenario, the Indian pharmaceutical manufacturers won’t be able to manufacture patented drugs. To adapt to this new patent regime, the industry is exploring business models, different from the existing traditional ones. New Business Models include: • Contract research (drug discovery and clinical trials) • Contract manufacturing • Co-marketing alliances Figure 23: Emerging models to capture the outsourcing opportunity

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The focus of the Indian pharma companies is also shifting from process improvisation to drug discovery and R&D. The Indian companies are setting up their own R&D setups and are also collaborating with the research laboratories like CDRI, IICT etc.

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Table 23: Government Run Research Organizations - Industry Collaborations

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3.3.2 Threat from China China is becoming a major competitor to India, especially in exports of active pharmaceutical ingredients (APIs). China’s pharmaceutical industry ranks no.7 in the world and is expected to become the world’s 5th largest by 2010. China’s domestic drug sales have been estimated at about US$8 billion in 2003 and the exports are growing at the rate of about 20% per annum. The reasons for Chinese competitive advantage are: The electricity costs are lower in China as compared to India. The power costs range from Rs.1.50 to 2.50 per KWH as against Indian cost of Rs.4.5 to 6.0 per KWH. Labour charges are 40% lower in China than India. More favourable labour policies like policy of hire and fire China has established a large number of profit oriented research and development institutions, which are today independent of government funding in contrast to institutions in India, which are mostly dependant on government funding. The Chinese government provides an income tax holiday of 100 per cent for the first two winning years (profit making years) and 50 per cent for the next 3 years. The companies are also allowed duty free import of capital equipment. Lower turnaround time for ships at Chinese ports make it conducive as a base for exports. China is an important source of chemical and APIs, whereas India is stronger on the finished product / formulation side. A comparison of competencies of the two countries is presented below Table 24: Competencies of India and China

India is the second largest export destination for bulk drugs / APIs for China (after US) and exports to India grew at 42 % in 2006, wheras exports to US grew at 9 %. If China and India can collaborate, CHINDIA can lead the world pharma market!!!

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3.4 SWOT analysis of the Indian pharmaceutical Industry It is often said that the pharma sector has no cyclical factor attached to it. Irrespective of whether the economy is in a downturn or in an upturn, the general belief is that demand for drugs is likely to grow steadily over the long-term. True in some sense. But are there risks? The succeeding paras gives a perspective of the Indian pharma industry by carrying out a SWOT analysis (Strength, Weakness, Opportunity, Threat). The SWOT analysis of the industry reveals the position of the Indian pharma industry in respect to its internal and external environment. 3.4.1

Strengths: India with a population of over a billion is a largely untapped market. In fact the penetration of modern medicine is less than 30% in India. To put things in perspective, per capita expenditure on health care in India is US$ 93 while the same for countries like Brazil is US$ 453 and Malaysia US$189. The growth of middle class in the country has resulted in fast changing lifestyles in urban and to some extent rural centers. This opens a huge market for lifestyle drugs, which has a very low contribution in the Indian markets. Indian manufacturers are one of the lowest cost producers of drugs in the world. With a scalable labor force, Indian manufactures can produce drugs at 40% to 50% of the cost to the rest of the world. Indian pharmaceutical industry posses excellent chemistry and process reengineering skills. This adds to the competitive advantage of the Indian companies. The strength in chemistry skill help Indian companies to develop processes, which are cost effective.


Weakness: The Indian pharma companies are marred by the price regulation. Over a period of time, this regulation has reduced the pricing ability of companies. The NPPA (National Pharma Pricing Authority), which is the authority to decide the various pricing parameters, sets prices of different drugs, which leads to lower profitability for the companies. The companies, which are lowest cost producers, are at advantage while those who cannot produce have either to stop production or bear losses. Indian pharma sector has been marred by lack of product patent, which prevents global pharma companies to introduce new drugs in the country and discourages innovation and drug discovery. But this has provided an upper hand to the Indian pharma companies. Indian pharma market is one of the least penetrated in the world. However, growth has been slow to come by. As a result, Indian majors are relying on exports for

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growth. To put things in to perspective, India accounts for almost 16% of the world population while the total size of industry is just 1% of the global pharma industry. Due to very low barriers to entry, Indian pharma industry is highly fragmented with about 300 large manufacturing units and about 18,000 small units spread across the country. This makes Indian pharma market increasingly competitive. The industry witnesses price competition, which reduces the growth of the industry in value term. To put things in perspective, in the year 2003, the industry actually grew by 10.4% but due to price competition, the growth in value terms was 8.2% (prices actually declined by 2.2%) 3.4.3

Opportunities The migration into a product patent based regime is likely to transform industry fortunes in the long term. The new patent product regime will bring with it new innovative drugs. This will increase the profitability of MNC pharma companies and will force domestic pharma companies to focus more on R&D. This migration could result in consolidation as well. Very small players may not be able to cope up with the challenging environment and may succumb to giants. Large number of drugs going off-patent in Europe and in the US between 2005 to 2009 offers a big opportunity for the Indian companies to capture this market. Since generic drugs are commodities by nature, Indian producers have the competitive advantage, as they are the lowest cost producers of drugs in the world. Opening up of health insurance sector and the expected growth in per capita income are key growth drivers from a long-term perspective. This leads to the expansion of healthcare industry of which pharma industry is an integral part. Being the lowest cost producer combined with FDA approved plants, Indian companies can become a global outsourcing hub for pharmaceutical products.


Threats: There are certain concerns over the patent regime regarding its current structure. It might be possible that the new government may change certain provisions of the patent act formulated by the preceding government. Threats from other low cost countries like China and Israel exist. However, on the quality front, India is better placed relative to China. So, differentiation in the contract manufacturing side may wane. The short-term threat for the pharma industry is the uncertainty regarding the implementation of VAT. Though this is likely to have a negative impact in the shortterm, the implications over the long-term are positive for the industry.

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Summary of the SWOT Analysis

3.5 Enviornmental analysis (PEST) Technological advancements, tighter regulatory-compliance, overheads, rafts of patent expiries and volatile investor confidence have made the modern pharmaceutical industry an increasingly tough and competitive environment. Below is an analysis of the structure of the pharmaceutical industry using the PEST (political, economic, social and technological) model. 3.5.1 Increasing Political Attention: Over the years, the industry has witnessed increased political attention due to the 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. 3.5.2 Economic Value Added: In the decade to 2003 the pharmaceutical industry witnessed high value mergers (like Pfizer\Pharmacia, Glaxo-Wellcome\SmithKline-Beecham and Novartis (a merger between Sandoz and Ciba Geigy)) and acquisitions. With a projected stock value growth rate of 10.5% (2003-2010) and Health Care growth rate of 12.5% (20032010), the audited value of the global pharmaceutical market is estimated to reach a huge 500 billion dollars by 2004. Only information technology has a higher expected growth rate of 12.6%. Majority of pharmaceutical sales originate in the US, EU and Japanese markets. Nine geographic markets account for over 80% of global pharmaceutical sales these are, US, Japan, France, Germany, UK, Italy, Canada, Brazil and Spain. Of these markets, the US is the fastest growing market and since 1995 it has accounted for close to 60% of global sales. In 2000 alone the US market grew by 16% to $133 billion dollars making it a key strategic market for pharmaceuticals. Page | 81

3.5.3 The Social Dimension: Good health is an important personal and social requirement and the unique role played by pharmaceutical companies in meeting the society’s need for popular wellbeing cannot be underestimated. In recent times, the impact of various global epidemics e.g. SARS, AIDS etc. have also attracted popular and media attention to the industry. The effect of the intense media and political attention has resulted in increasing industry efforts to create and maintain good government-industry-society communications. 3.5.4 Technological Advances: Modern Scientific and Technological advances are forcing industrial players to adapt even faster to the evolving environments in which they are participating. Scientific advancements have also highlighted the need for increased spending on Research and Development in order to encourage innovation. 3.5.5 Legal Environment: The pharmaceutical industry is a highly regulated and compliance bound industry. As a result, there are immense amount of regulatory and legal compliance overheads which the industry needs to absorb. This tends to restrict its dynamism. But in recent years, the government have begun to request industry proposals on regulatory overheads so as not to discourage innovation in the face of mounting global challenges from external market. 3.6 Structural industry analysis (Porter’s Five Forces) A summary of the pharmaceutical industry using Porter’s Five Forces model (see diagram below). The 5 forces approach can be used in initial diagnosis and as an aid to strategy development. Its main value is as a thought provoking aid to help arrive at a shared understanding of the threats and opportunities facing the firm. Figure 24: Porter’s Five Forces Model for Industry Analysis

3.6.1 Industry competition Page | 82

Pharmaceutical industry is one of the most competitive industries in the country with as many as 10,000 different players fighting for the same pie. The rivalry in the industry can be gauged from the fact that the top player in the country has only 6 % (2006) market share, and the top 5 players together have about 18 %(2006) market share. Thus, the concentration ratio for this industry is very low. High growth prospects make it attractive for new players to enter in the industry. Another major factor that adds to the industry rivalry is the fact that the entry barriers to pharmaceutical industry are very low. The fixed cost requirement is low but the need for working capital is high. The fixed asset turnover, which is one of the gauges of fixed cost requirements, tells us that in bigger companies this ratio is in the range of 3.5-4 times. For smaller companies, it would be even higher. Many small players that are focussed on a particular region have a better hang of the distribution channel, making it easier to succeed, albeit in a limited way. An important fact is that, pharmaceutical is a stable market and its growth rate generally tracks the economic growth of the country with some multiple (1.2 times average in India). Though volume growth has been consistent over a period of time value growth has not followed in tandem. The product differentiation is one key factor which gives competitive advantage to the firms in any industry. However, in pharmaceutical industry product differentiation is not possible since India has followed process patents till date, with loss favouring imitators. Consequently product differentiation is not a driver, cost competitiveness is. However, companies like Pfizer and Glaxo have created big brands over the years which act as product differentiation tools. Earlier it was easy for Indian pharmaceutical companies to imitate pharmaceutical products discovered by MNCs at a lower cost and make good profit. But today the scene is different with the arrival of the patent regime which has forced Indian companies to rethink its strategies and to invest more on R&D. Also contract research has assumed more importance now. 3.6.2 Bargaining power of buyers The unique feature of pharmaceutical industry is that the end user of the product is different from the influencer (read doctor). The consumer has no choice but to buy what doctor says. However, when we look at the buyer’s power, we look at the influence they have on the prices of the product. In pharmaceutical industry, the buyers are scattered and they as such do not wield much power in the pricing of the products. However, govt with its policies, plays an important role in regulating pricing through the NPPA (national pharmaceutical pricing authority). 3.6.3 Bargaining power of suppliers The pharmaceutical industry depends upon several organic chemicals. The chemical industry is again very competitive and fragmented. The chemicals used in the pharmaceutical industry are largely a commodity. The suppliers have very low bargaining power and the companies in the pharmaceutical industry can switch from their suppliers without incurring a very high cost. However, what can happen is that the supplier can go for forward integration to become a pharmaceutical company. Companies like Orchid Chemicals and Sashun Chemicals were basically chemical companies who turned themselves into pharmaceutical companies. 3.6.4 Barriers to entry Page | 83

Pharmaceutical industry is one of the most easily accessible industries for an entrepreneur in India. The capital requirement for the industry is very low; creating a regional distribution network is easy, since the point of sales is restricted in this industry in India. However, creating brand awareness and franchisee among doctors is the key for long term survival. Also, quality regulations by the government may put some hindrance for establishing new manufacturing operations. The new patent regime has raised the barriers to entry. But it is unlikely to discourage new entrants, as market for generics will be as huge. 3.6.5 Threat of substitutes This is one of the great advantages of the pharmaceutical industry. Whatever happens, demand for pharmaceutical products continues and the industry thrives. One of the key reasons for high competitiveness in the industry is that as an ongoing concern, pharmaceutical industry seems to have an infinite future. However, in recent times the advances made in the field of biotechnology, can prove to be a threat to the synthetic pharmaceutical industry. 3.6.6 Conclusion This model gives a fair idea about the industry in which a company operates and the various external forces that influence it. However, it must be noted that any industry is not static in nature. It’s dynamic and over a period of time the model, which have used to analyse the pharmaceutical industry may itself evolve. Going forward, we foresee increasing competition in the industry but the form of competition will be different. It will be between large players (with economies of scale) and it may be possible that some kind of oligopoly or cartels come into play. This is owing to the fact that the industry will move towards consolidation. The larger players in the industry will survive with their proprietary products and strong franchisee. In the Indian context, companies like Cipla, Ranbaxy and Glaxo are likely to be key players. Smaller fringe players, who have no differentiating strengths, are likely to either be acquired or cease to exist. The barriers to entry will increase going forward. The change in the patent regime has made sure that new proprietary products come up making imitation difficult. The players with huge capacity will be able to influence substantial power on the fringe players by their aggressive pricing thereby creating hindrance for the smaller players. Economies of scale will play an important part too. Besides government will have a bigger role to play. 3.7 Drug patents in India The Indian Patents Act, 1970 (effective since 1972) sought to provide only process patents for chemical substances including pharmaceuticals, agrochemicals and food products, and it granted product patents for non-chemical substances. The duration of process patents was fixed at seven years from the date of filling of the patent, or five years from the sealing of the patent, whichever is earlier. Considering the importance of sectors such as pharmaceuticals, the Indian Patents Act, 1970 added a few provisions, which sought to significantly restrict the scope of protection. (i) Under the license rights, a process patent owner is obliged to sell the license to any third party fetching a maximum royalty of 4% in turn. (ii) The Government retained the right to issue compulsory licenses (after 3 years from the date of sealing of a patent) if the product under question was above ‘reasonable’ prices or if it did not satisfy public interests. Page | 84

(iii) Import of patent protected products is not considered to be ‘working of patent’ and therefore the patentee must necessarily produce the same in the country within three years from the date of sealing of a patent. 3.7.1 Patent Protection under WTO, 1995 The Patents Act, 1970 has been instrumental in encouraging and developing the indigenous drug industry and indirectly containing medicine prices, but is currently under threat with the conclusion of the last Uruguay Round of General Agreement on Tariffs and Trade (GATT) negotiations in 1993 and the establishment of World Trade Organization (WTO) on 1 January 1995. In fact, extension of pharmaceutical product patents to all member countries was the key and controversial issue and also the last issue to be hammered out prior to tabling of the Draft Agreement at the end of 1991. A gist of the patents system, 1970 and the change-over envisaged under TRIPS is given in table below Table 25: A synoptic comparison of Indian Patents Act, 1970 and TRIPS, 1995

The erstwhile GATT (since 1995, WTO) sought to radically transform the patent Act in many countries. The specific article dealing with patents-Trade-Related Intellectual Property Rights (TRIPS) - requires that the signatories to GATT must necessarily amend their Constitution in accordance with this Article. The Article on TRIPS requires member countries to change their Act in such a way that they grant product patent to the pharmaceutical, chemical, food and agricultural sectors as well. The period of patent rights is to be changed in the Indian case from seven to twenty years. A proper amendment needs to be made to the Constitution of respective member countries amending the present rules. For developing countries, 1 January 2000 was fixed as the deadline for amending the Constitution. Developing countries like India have, however, been granted a five-year transition period till 2005. Until then, exclusive marketing rights (EMRs) would have to be granted to those companies introducing newly invented products. Domestic production of the patent-protected products is not mandatory wherein import is to be considered as a working of the patent. Even the Paris Convention specifically nails non-working or import of patentprotected products as an abuse of exclusive rights. The other retrograde step in the direction of TRIPS is the restrictions imposed on the free use of compulssory licensing provisions, which were hitherto available in the present India Patents Act of 1970. The provision of compulsory licensing (under the new dispensation) can be harnessed only when there is a clear case of national disaster or calamity. 3.7.2 TRIPS and its likely impact Several issues need attention in the wake of a change from process to product patent. These issues include price rise, market structure, foreign investment inflows, Page | 85

technology transfer, royalty and hence foreign exchange outflow, import dependence, etc. A sensitive and a highly controversial issue with regard to TRIPS is the concern about the high price of medicines. India was at the forefront in raising this issue backed by strong evidence. It is natural that many recent findings on this matter focused on likely price trends in India in the event of amending the present patents Act. Lanjouw (1998) found drug prices in India, particularly in the post-patent 1970 period, among the lowest in world. As a sequel to a transition to the product patents regime, drug prices in India are expected to considerably escalate to a high level. Simultaneously, however, he and a few others argue that given the current market conditions, it is estimated that only 10%-20% of the pharmaceutical products are under patent, and hence there is no need to focus on negative trends on the drug price front. It needs to be noted that once patented products start proliferating in the market, the composition of patented products in the total pharmaceutical market would undergo a drastic change in favour of the former. This would have a far-reaching influence on price. Recent studies, clearly show the extent of price increase that would be likely in the near future with a changeover from the present system to a patent monopoly era. The study by Fink (2000) suggest a surge in pharmaceutical prices in the range of 9%-76% if product patent rights are introduced. However, as far as the impact on various therapeutic categories is concerned, the upsurge in price would depend on the demand for new patented products or on the available alternative treatments, whichever dominates the market. Interestingly, Fink suggests that rapid acceleration in drug prices could be countered by various price control measures available with the local government, a provision allowed in the TRIPS agreement. Compulsory licensing is another tool to counter the adverse implications of conferring patent protection. Price ceilings, if put into effective practice, by allowing firms to charge normal profits in addition to production costs, would reduce or eliminate an inventor’s patent-induced market power. They further assert that when normal profits are granted the potential disincentive to invest would wither away resulting in recouping of R&D investment. In any case, the price of patented products is bound to be high. This could be because of several reasons: (i) formulation activity would be costly as multinationals would normally set high prices for the bulk drugs imported in view of global reference pricing; (ii) issuing compulsory licensing to any company in India would amount to enormous royalty fees, in return. This would naturally be reflected in the base price of the patented products; (iii) any effort to locally produce the patented medicine is nothing but monopoly production and consequently monopoly pricing, which will always be higher than the competitive price. However, a point worth noting in this context is that one must actually analyse the entire gamut of issues related to the pharmaceutical market and one cannot merely take such provision as given. An appreciation of the overall structural adjustment in economies such as India show that over the years, particularly since the early 1990s, pharmaceutical prices have been decontrolled to a substantial degree and in fact presently only a few drugs (75 essential drugs in 1998) are actually controlled. Many more of these are likely to witness lifting of controls in the immediate future, as made evident in the intentions of government policy pronouncements (GOI 2001). According to a McKinsey Report, by 2015 Indian Pharmaceutical Industry will be of US$ 20 billion, catapulting it within top 10 Pharmaceutical Markets of the world.

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Products Patented in India, as forecasted by McKinsey, will then value around US$ 2 billion contributing 10% of the IPM. 3.8 The future of Indian Pharmaceutical industry The dream of Indian pharmaceutical companies for marking their presence globally and competing with the pharmaceutical companies from the developed countries like Europe, Japan, and United States is now coming true. The new patent regime has led many multinational pharmaceutical companies to look at India as an attractive destination not only for R&D but also for contract manufacturing, conduct of clinical trials and generic drug research. The Indian companies are using the revenue generated from generic drug sales to promote drug discovery projects and new delivery technologies. Contract research in India is also growing at the rate of 20-25% per year and was valued at US$ 10-120 million in 2005. India is holding a major share in world's contract research Clinical Research Outsourcing (CRO), a budding industry valued over US$ 118 million per year in India, is estimated to grow to US$ 380 million by 2010, as MNCs are entering the market with ambitious plans. By revising its R&D policies the government is trying to boost R&D in domestic pharmaceutical industry. It is giving tax exemption for a period of ten years and relieving customs and excise duties of all the drugs and material imported or exported for clinical trials to promote innovative R&D. The future of Indian pharmaceutical sector is very bright because of the following factors: • Clinical trials in India cost US$ 25 million each, whereas in US they cost between US$ 300-350 million each. • Indian pharmaceutical companies are spending 30-50% less on custom synthesis services as compared to its global costs. • In India investigational new drug stage costs around US$ 10-15 million, which is almost 1/10th of its cost in US (US$ 100-150million). 3.8.1 What is in store for the future? • We can expect a significant level of consolidation- a major portion of small players are likely to be wiped out. • Many of the existing players are family owned businesses. No one should be surprised if many more deals on the lines of the Ranbaxy-Daiichi deal come through. It is the classic “bird in the hand” principle – if the founders can earn a few billions without too much effort, why should they spend hundreds of millions and ten years or more in trying to develop new drugs. • The present scenario presents an excellent opportunity for multinational enterprises to establish manufacturing bases in India through the take-over route. The availability of talented scientists at a relatively low cost makes India an ideal location for manufacturing quality drugs. A word of caution is necessary though such enterprises may have to follow a dual pricing policy, one for the local market and another for the global market. • The Indian government would do well to take another look at its policies. There is not much incentive for companies to invest in new drugs. The corporations engaged in R&D need tax breaks and innovative incentives. • SEZs will play an important role in the future of the pharmaceutical industry. Influx of outsourced work from global pharmaceutical companies has given Page | 87


the necessary impetus for the creation of pharmaceutical Special Economic Zones (SEZ), which would be one of the key drivers of outsourced pharmaceutical services growth in the coming future. The opportunity for Indian pharma companies is sizeable as generic drugs manufactured in India are now being accepted worldwide, and leading companies like Ranbaxy, Cipla and Dr. Reddy's are making way for others. Figure 25: Expected market share of Indian Players in the US Generics Market

By 2010-11, share of Indian companies in the U.S. market is expected to be more than 10 percent. Moreover, companies are not risking concentration by focusing only on the U.S. market by increasing attention to the European market for generics. 3.8.2 Issues and challenges Mergers and Acquisitions Currently, as the generics business is weighed down by stiff competition and declining R&D productivity, alliances and partnerships is the need of the hour for the pharmaceutical industry rather than the preference. In recent times, most of the leading players have inked M&A deals across the globe. In 2006, the domestic pharma sector executed more than 40 deals with 32 cross border transaction worth US$ 2000 mn and it includes deals like Dr Reddy’s acquisition of Betapharm of Germany for Euro 480 mn (Rs 2550 cr) and Ranbaxy Terapia buy in Romania for US$ 324 mn (Rs 1250 cr approx). In 2007, Indian pharma sector witnessed 25 Mergers & acquisition deals, with 15 cross border transaction worth US$ 600-700 mn. Thus, mergers and acquisitions has proved to be an important tool to seize growth opportunities and is widely resorted to by players by either moving up the value chain or by integrating downstream production. More mergers & acquisitions and consolidation activity in near future is expected which is driven in the medium term by implementation of the new patent regime and generic companies looking to establish a low-cost base out of the country. Attracting and retaining a skilled workforce Page | 88

The pharmaceutical business is knowledge and experience business and people have always been one of the most important resources for any pharmaceutical or biotech company. We can talk about brand but the people in a company, in particular in their behaviour, represent a living brand. We can focus on intellectual property but that is the creation of the people, and people joining or leaving a company will add to or reduce the sustainable intellectual property. We can talk about markets, but to access any market you need people with a good understanding of that market and the culture and values of customers and suppliers. Increasingly we talk about regulation and compliance as though they are some abstract function of a company. In practice we are describing the collective values and integrity of the individual members of staff, and the way they are motivated to behave in particular situations. The key is how an organisation attracts, recruits, develops, and motivates employees with competencies that set their business apart from those of the competitors. The first challenge is that there are increasing signs of the labour market moving in favour of the employee rather than the employer. There is growing demand for skilled people but traditional labour markets are providing fewer new people with the right qualifications and experience; and companies are still trying to recruit people with ever-more-specialised knowledge. It is possible to recruit from new markets, but this is a new competency for many companies. Controlling operating costs It is accepted knowledge that the pressure to control and reduce costs is one of the next major challenges to be faced by the pharmaceutical industry. But how is this done and what is the best approach? Understanding and controlling operating costs is a critical first step to developing or sustaining competitive advantage. Increasing generic competition, imminent patent expiries (revenue can decrease by up to 60% at patent expiry), shorter pipelines and the emergence of China as a low cost manufacturing base, all contribute to constantly eroding margins. To maintain or increase margins in the future, pharmaceutical companies need to start taking a proactive approach towards understanding costs. As the pharmaceutical industry embraces these new challenges, the companies that emerge at the forefront will be those who address the issues now and are able to account for all the costs throughout their organisation. To achieve this advantage, companies have to start recognising and targeting costs today. Infrastructure Compared with western industrial nations, energy prices are low but companies must expect repeated power cuts and offset fluctuations in the electricity network with the help of emergency power generators. In many areas, the hot and humid climate makes high demands on climate technology at production plants and on the refrigeration of finished products. Insufficient energy supply also leads to a situation where production hours must be handled very flexibly. This shortage can only be eliminated in the medium term and will require maximum effort. However, the Indian government intends to expand power generation capacities to roughly 240 GW by the end of the 11th five-year plan in 2012. This would mean a more than 100 GW, or nearly 90%, increase on today's total. Moreover, the country’s lacking transport infrastructure is increasingly turning into a major obstacle. The pharmaceuticals industry is especially dependent on road transport. However, the major transport links are chronically congested and many are in a poor state of repair. Of the total road network covering just over 3.3 million kilometres, only about 6% are relatively well Page | 89

built National and State Highways. In many cases, there are no paved surfaces or there is only one lane for all traffic. But the government has launched an extensive investment programme entitled the National Highway Development Programme, to be implemented by the middle of the next decade. Impact of new patent law Legal changes in India in 2005 made it considerably more difficult to produce “new� generics. Foreign pharmaceuticals, which enjoy 20 years of patent protection, can no longer be copied by means of alternative production procedures and sold in the domestic market. Hence, a reorientation was required in India’s pharmaceutical industry. It now focuses on drugs developed in-house and contract research or contract production for western drug makers. Thus, this transition phase of reorientation is a challenge for the industry.

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4.0 THE TRIPS AGREEMENT 4.1 Introduction Most developed and developing countries are either members or observers of the World Trade Organization (WTO); this means they are committed to follow the rules laid down in its Agreements, or intend to make these commitments in future. One of these WTO Agreements is the Agreement on Trade Related aspects of Intellectual Property Rights (TRIPs). The TRIPs Agreement makes the granting of patents for pharmaceuticals obligatory. Since previously many developing countries allowed only for limited patent protection in this area, this represents a significant change in the pharmaceutical sector. Proponents believe this will lead to an increase in investment and in R&D, yet numerous public health experts, as well as consumer groups, have expressed concern about the impact of the TRIPS Agreement on the availability and prices of drugs. Moreover, worldwide, there is growing concern about the impact of the intellectual property rights system on innovation and on investment. A global process of rethinking is starting, in which developing countries should actively participate. The TRIPS Agreement is not a uniform law, but a framework that sets (minimum) standards and conditions for the protection of intellectual property. These are made operational via the national intellectual property rights (IPR) legislation. Within the TRIPs framework, there is some room for manoeuvre, which can be used to design legislation which is in the best interest of the country. Measures to protect the public interest ought to be included in the national legislation, and should encompass public health aspects. In fact, TRIPS provides for a number of safeguards which may be used to protect public health and promote competition, such as compulsory licensing, and allows for exceptions which may facilitate the marketing of generic drugs. These safeguards can be used to mitigate potential negative impacts of increased IPR protection in the pharmaceutical sector on access to drugs. However, these safeguards can only be used if they have been incorporated in the national Legislation Safeguards such as provisions for compulsory licensing are an essential element of IPR legislation, since they signal to the patent holder that, in the case of abuse of rights and/or non-availability of the product, a third party could be allowed to use the invention. As such, they reduce the risk of misuse of the monopoly rights conferred by a patent. However, to ensure that such safeguards can be used effectively, it is important to carefully state the grounds and conditions for their use in the national legislation. TRIPS requires that patents are granted when the typical standards for patentability, that is, novelty, inventive step and industrial applicability, are met. But the Agreement does not specify how these criteria should be defined; WTO member countries may decide how to apply these criteria. In the pharmaceutical sector, applying these criteria in a flexible way will facilitate the granting of ‘secondary’ patents, such as formulation patents, patents on polymorphs etc. Even if such secondary patents are relatively weak, they can be used aggressively to (threaten to) litigate, in order to stop competition. Therefore, defining the scope of patentability at the national level is an important issue. Similarly, enforcement rules can have significant implications, since, once a patent has been granted, there is a presumption of validity. If countries have strong provisional measures under their enforcement system, these can be used to prevent competition for instance while a lawsuit is pending (which can be several years). In the absence of competition, monopolistic pricing may reduce people’s access. However, if eventually a patent is found to be Page | 91

invalid or an enforcement rule to be unjustified, from a societal point of view it is important to consider who will reimburse the consumers, and how many people have in the meantime been denied access to essential medicines. 4.2 Background The philosophy of Intellectual Property Rights Intellectual property rights (IPR) deal with the creations of the human mind. The intellectual property rights system has been developed in order to try to achieve two contradictory aims: • to promote the publication of ideas, inventions and creations, in order to make them available to others, who can then further improve them; this will nurture scientific progress or artistic inspiration; • to provide an economic incentive for people to invent or to engage in creative efforts, by ensuring that the originator can reap financial rewards from his/her efforts. The solution adopted was to give the inventor or creator a temporary monopoly, in exchange for making his/her idea known to society. In the pharmaceutical sector, patents are the most important form of IPR protection. Patents are more difficult to obtain than other forms of IPR (an application has to be filed at, and approved by, the patent office); they are only valid when issued and in the country where they are issued. For an invention to be patentable, it has to meet three criteria: novelty, inventiveness and industrial applicability or utility. In other words, apart from being new, an invention should not be obvious to people skilled in the art or field of technology and it should have a potential for industrial application in order to be patentable. A patent requires the inventor to disclose his invention, in exchange for a temporary monopoly on its use. Because of this (temporary) monopoly, the inventor will be able to earn a profit in case of commercialization of the invention, either through direct exploitation, or through royalties in case a third party is given a license to use the invention. So historically, a patent was perceived to be an inexpensive way for society to encourage innovation and reward the inventor. A patent however does not in itself guarantee profits; a patented invention will only return profits if it is successfully commercialized - that is, if society finds the invention useful. Because patents are private rights, the costs of patent application, as well as of its protection (e.g. litigation in case of infringement by an unauthorized party) are to be borne by the patentee (patent holder). Furthermore, most legal systems contain provisions for government intervention, in case the patentee misuses the monopoly rights, e.g. when the availability of the patented product falls seriously short of demand. Patents can be granted for a product or for a (production) process. A product patent confers monopoly rights over the product, regardless of the production method. A process patent on the other hand confers rights over the process and over the products directly produced by that process. Production of the same product via a different production method however does not infringe a process patent and is allowed.

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4.3 The importance of intellectual property rights for national development In the pharmaceutical sector, patents are very important. In fact, the very existence of the TRIPs Agreement is due to the pressure from the big pharmaceutical companies on the US government, which in turn insisted that this issue should be on the agenda of the Uruguay Round negotiations. There are several reasons for the importance of patents for the pharmaceutical industry: 4.3.1 The costs of pharmaceutical R&D are high. While the actual amount is being disputed, it is in any case significant. 4.3.2 There is a disclosure requirement, at registration, 4.3.3 Usually, imitation is relatively easy; therefore the patent is important to protect the invention. 4.3.4 It allows the company to make extra profits. Because of the monopoly rights the patent confers, the company can charge a higher price and earn more than would have been possible in case of free competition. Obviously, from these profits, R&D costs have to be recovered; however, the US Office of Technology Assessment has published a study, which showed that profits in the pharmaceutical industry are considerably higher than in other industries and that the rate of return is much higher than what is needed to cover the costs. With regard to impact on development, two aspects of development can be distinguished: economic aspects and social or human aspects. Ultimately, the latter are the most important, so intellectual property rights should be looked at from this angle. Pharmaceutical patents are a clear example: the inherent effect of patents is to increase the price, which will reduce access. Therefore, in terms of social development, the impact of pharmaceutical patents is negative. On the other hand, however, patents may have positive 'dynamic effects' so far as they foster the development of new products that benefit society. When contemplating the importance of patents for national development, policymakers should make a profile of their country, taking into account the level of development, and, based on that, evaluate the importance of patents. Moreover, when designing patent laws, the limited room for manoeuvre built into the TRIPs Agreement should be used, in order to make sure that the national patent law works in the interest of the country’s social as well as economic development. 4.4 WHO's perspective on globalization and access to drugs 4.4.1 Global pharmaceutical challenges At the beginning of the 21st century, too many people still lack access to essential drugs. WHO estimates that more than one third of world's population lacks regular access to the medicines they need. In developing countries, 10.3 million children under five years of age died last year; 8.6 million of these deaths could have been prevented if those at risk would have had access to essential drugs. Today, in 32 countries, more than half the population lacks regular access to basic, essential drugs. The reasons for this are multiple and complex, and include the following factors: Public spending for healthcare in general and for drugs in particular is insufficient, and decreasing. Health insurance is non-existent or has very limited coverage; most people, especially in developing countries, have to pay for drugs out-of-pocket. New essential drugs are costly. Page | 93 Supply systems are often unreliable and poorly managed, leading to wastage and shortages. Ensuring access to essential drugs depends on several factors, such as rational selection of the drugs allowed on the market, affordable prices, sufficient and sustainable financing for drugs and a reliable health care and drug supply system. Price is only one of the factors in ensuring access to essential medicines; however, especially for countries and populations with limited resources, it is an important factor. One of the most effective strategies for promoting affordable prices is to increase competition (see figure 26). Previously, many developing countries did not, or only to a limited extent, grant patents for pharmaceutical products, in order to encourage (generic) competition. The TRIPs Agreement makes the granting of patents for pharmaceutical products and process inventions obligatory, for a minimum period of 20 years. For most developing countries, these new standards represent a considerable increase in the protection granted for pharmaceuticals. They fear therefore an increase in prices of medicines, and a further reduction in their population's already limited access. Figure 26: Effect of competition on HIV/AIDS drug prices

Adapted from: UNAIDS, B. Samb, 2000

However, the TRIPs Agreement contains a number of safeguards, which may be used to protect public health and promote competition, such as compulsory licensing and exceptions which facilitate the marketing of generic drugs ("Bolar exception"). These safeguards can be used to mitigate the potential negative impact of the TRIPs Agreement on access to drugs. However, in order to use these safeguards, countries have to incorporate them in their national legislation. 4.4.2 WHO policy perspective: In the context of globalization and access to medicines, WHO insists that access to essential drugs is a human right and that medicines are not simple commodities. WHO Page | 94

recognizes that patents on pharmaceuticals will stimulate R&D of new drugs, but also notices that research priorities tend to respond to (economic) demand, rather than to medical need. Therefore, WHO recommends that: Patents on pharmaceuticals should be managed in an impartial way, protecting the interest of the patent holder as well as safeguarding public health. Public investment is needed to ensure development of new drugs. Support should be given to any measures which will improve access to all essential drugs, including mechanisms to promote competition, such as providing comparative price information, promoting generic policies, reducing duties, taxes and mark-ups, allowing parallel imports, equity pricing of newer essential drugs and making use of the TRIPs safeguards. 4.5 The history of the TRIPs negotiations In order to increase the understanding about the TRIPs Agreement, it is useful to briefly consider the history of its negotiation. Before the Uruguay Round, about 50 countries did not grant patent protection for pharmaceutical products; this included a number of developed countries, such as Portugal and Spain, as well as many developing countries, for instance Brazil, India, Mexico and Egypt. TRIPs Article 27, which states that patents should be granted in all fields of technology without exclusion, therefore meant a significant change for the pharmaceutical industry; suddenly patenting of pharmaceutical products was made almost universal, since all WTO member states were obliged to grant it. Industrialized countries argued that patent protection in all fields of technology, as stated now in TRIPs Article 27, would have three main effects in developing countries: • there would be more foreign direct investment (FDI), • it would promote the transfer of technology, • patent protection would promote local R&D. Developing countries were reluctant to extend patent protection to pharmaceuticals. They realized that pharmaceutical production was highly concentrated in developed countries. More importantly, innovation -the development of NCEs- was almost exclusively undertaken in industrialized countries. At that time, 96% of worldwide R&D expenditures took place in developed countries and only 4%, in all areas of science and technology, in developing countries. This is perhaps the most dramatic asymmetry in contemporary North-South relations, since it relates to the ability to create and apply new scientific and technologic knowledge. In addition, even before the adoption of TRIPs, a number of economic studies showed that patent protection for pharmaceuticals in developing countries would lead to an increase in prices for medicines, to an increase in royalty and profit payments abroad and to a greater market penetration by foreign firms. Finally, the experience even of developed countries, such as Italy, which had recently adopted patents for pharmaceutical products, raised further doubt whether there would be any benefits. For almost 3 years, from 1986 until May 1989, developing countries refused to negotiate an agreement on intellectual property. But finally it was not possible, politically, to avoid the discussion and the drafting of the Agreement started. For developing countries, there were two potential benefits in negotiating the TRIPs. First, the trade-offs; the possibility that in other areas of the Uruguay Round negotiations, developing countries could obtain benefits, for instance access to markets for textiles and agricultural products. Unfortunately, for most developing countries it seems there have been less benefits than expected. Page | 95

Second, under the agreement there is a multilateral system for dispute settlement; the expectation was that, by having such a system, unilateral action by the US -on the basis of "Special" section 301 of their Trade Act- would cease. The US applies the 301 or super 301 section in order to threaten or retaliate with trade sanctions against countries on the basis of what they consider to be 'non-compliance with adequate standards of intellectual property'. Unfortunately this expectation has not been fulfilled either; the US has continued to use section 301. The views of Japan and the EU during the negotiations are interesting too. Their main interest was that, while an Agreement should establish a certain level of protection, it should not amount to a restriction to trade. For instance, the TRIPs position on parallel import -countries are free to decide whether or not they allow this- should be looked at from this perspective. Moreover, Japan was concerned about potential abuses of the system, since rights on intangible property may be properly used but also can be abused; in fact the US has quite a long tradition of anti-trust cases related to the abuse of IPR, which have led to the granting of a number of compulsory licenses. 4.6 Stakeholders' views Three important stakeholders are the innovative pharmaceutical industry, the national pharmaceutical industry and the consumers. 4.6.1 The international innovative pharmaceutical industry's perspective The importance of intellectual property rights for pharmaceutical R&D New medicines and access to these new medicines, which will be vital in the fight against communicable and non-communicable diseases, are dependent on strong patent and other intellectual property protection. "The patent system ‌. secured to the inventor, for a limited time, the exclusive use of his invention; and thereby added the fuel of interest to the fire of genius in the discovery and production of new and useful things." Abraham Lincoln, 1859 The patent system represents a compromise between competing short-term and longterm economic and social interests. Along with a well-functioning regulatory structure and marketing system, it allows the private pharmaceutical industry to operate and contribute to a socially driven public health sector by providing it with cost-effective new technologies. The commercial sector discovers and develops nearly all new drugs and vaccines, but this is expensive and risky; the patent system provides the incentive necessary to investigate thousands of new compounds and to invest an average of several hundred

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Table 26: Importance of patent protection for development of innovative products in various industries

million dollars in R&D. The dependence of pharmaceutical and vaccine discovery and development on adequate and enforceable intellectual property rights is the highest among various sectors. Table 26 shows that the first rank is held by the pharmaceutical industry. In some developing countries, which have adopted stronger patent protection in recent years, such as Korea, drug R&D has been rising. This is a fundamental change, which promises to improve the supply of effective new drugs and vaccines and to improve access to medicines for patients worldwide. However, recently, "compulsory licensing" has been touted as a magic policy to improve access to medicines in developing countries. Compulsory licensing of a patent to a competitor, provided for in some way in most countries, is normally limited in application to extraordinary circumstances, often related to technology issues in industry mergers. Proponents of an activist compulsory licensing (CL) system see the issue in terms of consumer price benefits arising from effectively abrogating the patent's marketing exclusivity. They ignore many of the problems with this approach: • it assumes that there is a licensee that can duplicate the originator's skills in manufacturing an equally safe and effective product; • it assumes that governments will use this "tool" as a pro-consumer tool, leading to cheaper drugs. However, governments tend to use CL measures for industrial policy; • most damaging, if a country adopts CL measures or if a disease area (e.g. HIV/AIDS) is subject to CL policies, fewer research funds will be allocated to that country or disease. Finally, the protection of trademarks, also under TRIPs, helps to clean up counterfeit products from the marketplace. The effect on public health is that through the reduction of trade in unregulated counterfeit products, the quality of the drug supply is improved.

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Problems of access to drugs With regard to inadequate access to drugs, two major gaps can be identified: • a "discovery/development" gap between the morbidity/mortality and available remedies; and • an "access imbalance" between consumption of medicines in the developing and the developed world. The exposure of poorer countries to the discovery/development gap is particularly acute because of mitigating circumstances of poverty, poor infrastructure and urbanization. In addition, there are other pharmaceuticals-related gaps that contrast the health situation in the "North-South" context: • The Quality/Counterfeit Medicines Gap: Patients in developing countries are more frequently exposed to substandard products and counterfeits, due to the relatively large gap in regulatory capability and training between developed and developing countries as well as the differences in enforceability and penalties for counterfeiting activities; • The R&D Imbalance: While the relative incidence of infectious diseases is higher in developing countries, until now little pharmaceutical research and development has taken place in these countries; • The Urban/Rural Gap: The minority of the population living in towns receives three-quarters or more of medical services and products; this is a global phenomenon, but it bears most heavily on poorer populations in developing countries; and, • The Drug Production Imbalance: With over 3/4 of the world's population, developing countries produce less than 1/10 of drug output; further, 2/3 of the latter production is concentrated in a few developing countries, such as India, China, Egypt, Republic of Korea, Brazil. Thus, many developing countries have choices of products from just a few sources. Improving access conditions means focusing on a wide number of factors restricting access to health care and medicines. For instance, in developing countries, funding is often insufficient to provide even the most basic healthcare services and products. Usually, people working in the informal sector cannot enter the social security health care system. These are just a few examples to illustrate existing barriers. Cost and Price Issues There is no price at which a 'non-invented' drug can be purchased. In the absence of a new drug, the 'price' of a treatment or cure is infinite. Innovation makes a therapeutic option available. Further, therapeutic competition among alternative drugs drives market prices lower, with post-patent conditions making the product a generic 'commodity' subject to even greater competitive pricing pressures. Moreover, according to the innovative pharmaceutical industry, the following issues should be considered: • Regarding the impact of patents on price, the linkage is weak or non-existent since price levels are determined by many factors: distribution conditions and markups, price controls, inflation, taxes, measurement techniques etc. A 1995 study showed that countries with intellectual property protection did not have higher prices than countries without such protection. The Children's Vaccine Initiative noted that while patents and royalties do not raise the price of vaccines 'dramatically', "… countries which do not recognize IP…. may actually inadvertently hinder access to vaccines… by discouraging legal vaccine technology transfer and by failing to encourage domestic vaccine research and development". Page | 98

• Patents do not, in fact, have an influence on access to those drugs which most of the population in developing countries actually consumes, which are primarily offpatent drugs. • Countries without effective patent protection could produce their own versions of patented products. In fact, India already produces generic copies of patented AIDS drugs. If patents were indeed the problem, large populations within India should have easy access to these generic versions of AZT and other medications; but this is demonstrably not the case. Access is poor in some countries regardless of the status of patents. • Patented products also face competition from off-patent products for the same conditions as well as from other therapeutic alternatives. Indeed, the time between the introduction of an innovative drug and of therapeutically similar products has lessened dramatically over time. • Generic production is not an automatic answer to access; generic producers in developing countries may charge lower prices than the original innovator, but prices are still above levels which most people in developing countries can pay.

Figure 27: Estimated Drug Life Cycle

Source: Dr H. E. Bale

Recommendations The following global actions are suggested to improve access and innovation in the areas of medicines and vaccines for the benefit of developing countries: • Encourage public-private partnerships for the development and distribution of medicines and vaccines where existing therapies are lacking or not getting adequately distributed. • Develop a global "orphan-type" incentive plan, using market exclusivity and tax incentives to encourage companies both in the North and South to perform research and develop drugs for currently neglected diseases. • Foster public-private vaccine partnerships to stimulate the development of Page | 99

new drugs and vaccines and/or to increase international financing for their distribution, such as the Medicines for Malaria Venture or the Global Alliance for Vaccines and Immunization. • Foster local industry investment in R&D and transfer of know-how into developing countries by accelerating the adoption of TRIPs standards for intellectual property rights; local companies must shift their activities from copying drugs to developing new drugs, which are important in the fight against priority diseases. • Encourage local innovation by avoiding price controls, either directly or indirectly. Price controls tend to reduce the supply of newer innovative therapies and can have a distinctly dampening effect on innovation in pharmaceuticals, a trend which has been observed in Europe as well as in Japan. Price controls are a very short-sighted policy: while they may make current medicines cheaper, in the long run they will make developing new drugs more difficult. Furthermore, as price controls often go from being "price ceilings" to "price floors", they can lead to higher prices in the medium- to long run, compared to permitting competitive pricing in the post patent period. • Stimulate the supply of affordable quality generics in developing countries by working to inculcate the importance of quality manufacturing procedures locally. Negative approaches, such as attempting to withdraw trademarks for medicines, should be avoided. Trademarks are a sign of the origin of a medicine, and trademark owners must therefore stand behind the quality of the product. If consumers avoid unbranded generics it is not because of trademarks, but rather because consumers lack confidence in their quality. Thus the answer is to focus on quality. To deny trademarks rights would be to soften the pressure on generic drug producers to produce high standard medicines. • Ensure the supply of needed drugs by working to prevent parallel trade. Parallel trade is product diversion, which may seem seductive if a country's officials believe that they will be receiving relatively low-priced imports. However, parallel traders would be buying up supplies of essential drugs in a low-price country for resale in higher-priced markets, thus diverting them from the population who needs them. When parallel trade is discussed, it is always assumed by proponents that there are only parallel imports, and that there is no diversion of key products via parallel exporters. However, if it is assumed that parallel imports can make a significant difference in lowering the price domestically, then someone else abroad must be paying more through this diversion. Furthermore, even for importing countries, the alleged benefits of parallel trade tend to be less than expected. The European Union's experience shows that the benefits of parallel trade accrue mainly to the parallel traders, not consumers, because the former capture most of the "rents" arising from the differences in ex-manufacturer prices across countries. In addition, parallel trade increases opportunities for counterfeit and substandard products to enter the market, creating increased health and safety risks for consumers, as well as increasing the burden on inadequately resourced regulatory staff in developing countries. • Consider creating publicly financed research centres in the region to foster medical research, pooling the scientific expertise and resources of several countries, to increase the capacity for research in diseases of regional interest. While industry does its own drug discovery and drug development research, it also has worked with public agencies, such as the National Institute of Health (NIH), to build on basic research to bring new compounds to patients. Perhaps through such a mechanism ASEAN countries and local and international industry together could develop effective Page | 100

treatments for malaria, TB, HIV/AIDS, cancer and depression over the next decade or so. • Join with judicial authorities, the police and industry professionals to implement anti-counterfeiting legislation. Severe penalties should be imposed. • Adopt global drug review standards to speed up the approval of new drugs. Improved access to medications can be helped through reducing unnecessary tasks and duplication in the review of drugs internationally. One major effort, conducted in partnership between the public and private sectors, is the International Conference on Harmonization (ICH); its mission is to improve the efficiency of the registration process for new pharmaceutical products, specifically in Europe, Japan and the USA. • Empower consumers to choose well. Another vital aspect of effective access to medicines relates to information about these medicines and their proper use. Patients and consumers around the world are increasingly seeking more information about medicines to empower themselves in their own medical care. The Internet, as a truly global medium, has the potential to be a positive resource, but the use of the Internet to distribute medicines can also pose dangers. In the area of globalization of information and trade, governments and international institutions need to consider appropriate policies regarding this new health care medium. 4.6.2 The national pharmaceutical industry's perspective Intellectual property rights are a compromise between the incentive to create knowledge and the desirability of disseminating knowledge at little or no cost. While the debate deals with positive and negative implications, there is no systematic empirical evidence for either concerns that intellectual property rights would slow innovation or for their alleged positive impact on research and development. Intellectual property rights can disadvantage developing countries in two ways, namely by increasing the knowledge gap and by shifting the bargaining power towards the producers of knowledge, most of whom reside in developed, industrial countries. Effects on distribution might be particularly strong with respect to the effects of patents on the price of medicines, due to the weak bargaining power of developing countries in negotiating prices with monopoly suppliers. National pharmaceutical industries in developing countries are concerned about trends to focus R&D efforts exclusively on problems for which lucrative markets exists, such as impotence, obesity, jet-lag and baldness, rather than on widespread, serious tropical diseases. It is also worth noting that most industrialized countries, while having a patent system in place since a long time, introduced product patents for drugs only relatively recently (see Table 27); that is, after their pharmaceutical companies had attained a very high degree of development. Table 27: Introduction of patents

Source: World Bank

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Noting the above and other concerns, the implications of TRIPs Agreement on the national pharmaceutical industry might be: • When markets are small, there will be no interest to invest in technology transfer. • Several case studies indicate that there is little evidence that the introduction of TRIPs compliant standards of IPR would stimulate transfer of technology, encourage foreign direct investment, strengthen research, development and innovation and ensure early introduction ofnew products. • The introduction of new products by national industries will be delayed. • New medicines will be more expensive. • This may create an impression of denying people the right to new drugs. • The gap between local and multinational companies will widen. • There will be a shift in market share from generics to branded/originator products. The national pharmaceutical industries therefore believe that Governments should introduce appropriate policies to alleviate possible negative implications, such as those listed above, of the introduction of TRIPs standards. 4.6.3 A consumer's perspective (Consumers International) Access to essential drugs and affordable medical services are major consumer concerns. Currently, over two billion people do not have regular access to life-saving drugs, this, consumer organizations believe, is a crisis situation. The multinational companies (MNCs), particularly the American industry, have been advocating that developing countries need to provide strong patent protection for pharmaceuticals (20 years) in their national legislation. During this period, the patent holder will have an exclusive monopoly for the manufacture, distribution and sales of the patented drugs. Generic manufacturers can copy them only after the patents expire. If developing countries have to wait for 20 years to manufacture new lifesaving drugs, they will be waiting in vain. Modern drugs have a short lifespan. The top sellers of today will be almost extinct in about 10-15 years. Table 28 gives the US ten top prescription drugs in 1983 and traces their ranking during the following 14 years. Table 28: Top prescription drugs in 1983 and their ranking in 1988 (US) and 1997 (world)

Source: (1) 1983 & 1988 US ranking, SCRIP No. 1381, Jan 27, 1989, p. 17. (2) 1997 Ranking: Annual Report 500 Drugs: 500 Prescription Drugs by worldwide sales, Pharma Business, July/August 1998.

Of the top ten US prescription drugs in 1983, only three were able to retain their ranking within the top ten after five years. None of them was in the top 100 in 1997, Page | 102

and 4 drugs were not even in the list of the 500 top selling drugs that year. The consumer organizations, therefore, reject the position taken up by MNCs, that the TRIPs Agreement should be implemented in ways which would prevent compulsory licensing and parallel imports. Consumers reject this position because no drug at the end of 20 years will be worth manufacturing. The prices fixed indiscriminately by the MNCs, will prevent access of the life-saving drugs to over two billion people. Table 29: Retail prices in USD of 100 tablets Zantac in 11 Asian countries

Source: Retail Drug Prices: The Law of the Jungle, HAI News No. 100, April 1998.

A major argument put forward by multinational drug companies for strong patent protection is to have exclusive rights for a period of time so that they can earn adequate profits to cover their costs of R & D and to continue further R&D. This seems to be a justifiable argument. Therefore, we would need to know how much profits MNCs make, how much it costs to develop a new chemical entity and the amounts MNCs really spend on R&D. Unfortunately, independent data on the cost of R&D are scarce. Comprehensive research and development to discover and develop new chemical entities require human, technological and financial resources, which, at present, are available in only 10 advanced industrial countries. The United Nations Industrial Development Organization (UNIDO) has classified 190 countries into 5 groups based on the degree of development of pharmaceutical technology and industrial production. Table 30: A typology of world’s pharmaceutical industries

*) Each

country in this group discovered and marketed at least one NCE

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Consumers have expressed the following concerns: • The TRIPs Agreement represents an unprecedented transfer of power over economic functioning from the heads of nation states to MNCs. • There should be a major review of the WTO multilateral trade agreements. Subsequent reforms should incorporate as a central objective the promotion of sustained development in the Third World. • The special problems of the least developed countries (LDCs) should receive particular attention. In 1978, according to the United Nations, there were 28 LDCs. In 1998 there were 48. The rapid decline into poverty is due to rapid liberalisation, imposed by WB/IMF structural adjustment programmes and, recently, WTO. • Trade policy should be a powerful instrument for economic development, and this aspect must not be lost sight of by narrowly focussing on liberalisation. Based on analysis of empirical data on the impact of the TRIPs Agreement on access to drugs and health services in developing countries, the UNDP's Human Development Report 1999 has listed the following concerns: • Liberalisation, privatisation and tighter intellectual property rights are shaping the path for the new technologies, determining how they are used. But the privatisation and concentration of technology are going too far. Corporations define research agendas and tightly control the findings with patents, racing to lay claim to intellectual property under the rules set out in the TRIPs Agreement. • Poor people and poor countries risk being pushed to the margin in this proprietary regime controlling the world’s knowledge. • In defining research agendas, money talks, not need. Cosmetic drugs and slow ripening tomatoes come higher on the priority list than drought-resistant crops or a vaccine against malaria. • Despite the risks of genetic engineering, the rush and push of commercial interests are putting profits before people. • From new drugs to better seeds, the best of the new technologies are priced for those who can pay. For poor people, they remain far out of reach. • Tighter property rights raise the price of technology transfer, blocking developing countries from the dynamic knowledge sectors. The TRIPs Agreement will enable multinationals to dominate the global market even more easily. • New patent laws pay scant attention to the knowledge of indigenous people. These laws ignore cultural diversity in the way innovations are created and shared – and diversity in views on what can and should be owned, from plant varieties to human life. The result: a silent theft of centuries of knowledge from some of the poorest communities in developing countries. • There is a need for a comprehensive review of the WTO Agreements to redress their perverse effects, undermining food security, indigenous knowledge, biosafety and access to healthcare. The people’s response has been loud and clear during the violent events in Geneva, Seattle, Davos and other places. Why have people reacted so violently? People see that power is controlled by market forces operating under faulty global governance supported by rules, institutions and practices that have been formulated by a selected few. People ask that they be given a participatory role in decision making to ensure that people will be put at the centre of development and that the highest priority be given to goals of enhancing social development and ensuring human well-being for all throughout the world. People want a restructuring of the present global governance Page | 104

with a new set of rules, institutions and practices that will ensure global responsibility, so that the benefits of globalisation will be shared equally by all the people of the world and not exclusively by the 20 per cent of the people living in the richest countries. To conclude, consumers believe it is critical to examine the TRIPs Agreement and explore the best options in interpreting and incorporating relevant provisions into national legislation. The better options will be those that will strengthen the technological, economic and commercial development of the pharmaceutical sector in developing countries, which ultimately will ensure regular access to affordable, good quality, safe and effective drugs. Moreover, long term solutions would include a World Trade Organization that ensures both free and fair international trade, with a mandate extending to global competition policy with antitrust provisions and a code of conduct for multinational corporations. 4.7 Country experiences 4.7.1 Experiences with the introduction of patents for pharmaceuticals In most developing countries, TRIPs standards became enforceable only a few months ago; therefore time is too short to have evidence about its implications. But the experience of countries which have adopted pharmaceutical patents in the past decade is relevant in this context. What happened to foreign direct investment (FDI), transfer of technology and (local) R&D? What happened to drug prices? Latin America Several Latin American countries, such as Chili and the Andean countries changed their patent legislation in 1990/1991; pharmaceuticals became patentable. With regard to FDI, the experience of countries such as Chili, Colombia and other Andean countries is that after the adoption of patent protection for drugs, FDI in the pharmaceutical sector has not increased, except through the acquisition of local companies by foreign companies. But there has been no new investment. In addition, a large number of formulation plants have been closed down. So after the introduction of the patents, many foreign companies have decided not to produce (or formulate) locally any more, but to import. As a result, there was no increase in FDI and the trade deficit in this area has increased substantially due to the substitution of local production by direct import. With regard to the transfer of technology, unfortunately, the situation is not better. As mentioned, many local companies have been acquired by foreign companies; there is no clear increase in transfer of technology to local companies. In general, in the area of pharmaceuticals, there is little real transfer of technology. License agreements usually mean that the patent holder provides the active ingredient, not the technology for the production of the active ingredient, and the licensee is usually just formulating. Therefore it can be concluded that transfer of technology in this area was never very substantial, and has not increased. Finally, there is no sign of any increase in pharmaceutical R&D in these countries, nor are there any clear prospects that R&D for diseases relevant to developing countries will increase in industrialized countries. Italy Italy has introduced patent protection for pharmaceuticals in 1978. At that time, Italy was a reasonably large producer of pharmaceutical products and an exporter with a trade surplus. A number of years after the introduction of these patents, prices for Page | 105

medicines in Italy had increased significantly, almost 200 %, and Italy began to be a net importer of pharmaceutical products, going from a trade surplus in pharmaceuticals to a very severe trade deficit in this area. Thailand The first patent law in Thailand was enacted in 1979, and excluded pharmaceuticals. It was revised in 1992; the essence of the revision was the inclusion of pharmaceutical product and process patents. A further revision, introducing petty patents and addressing the issue of parallel import, was enacted in March 1999. A study to assess the impact of the introduction, in 1992, of patent protection for pharmaceuticals concluded that: • technology transfer in the pharmaceutical sector has been minimal and has been limited to formulating techniques; no increase in technology transfer was seen after the enactment of the 1992 patent law; • technology that could lead to R&D of new pharmaceutical products in Thailand is not likely to be transferred; • since the enactment of the 1992 patent act, there has been an increased tendency to import drugs (compared to local production), indicating that foreign companies benefited more from change in patent law than local companies; the share of originator products as percentage of the total pharmaceutical market increased, on average by 4% per year; • there has not been much foreign direct investment in the pharmaceutical sector since 1992; • for products already on the market, the study did not reveal any price change, however, due to the selection of products (all selected drugs had competitors in the Thai market) and a variety of interfering factors, the question of the impact on drug prices is in fact not answered by the study. 4.7.2 Development of TRIPs-compliant legislation in developing countries While experience with the actual implementation of TRIPs in developing countries is limited, a number of observations can be made based on countries' preparations for becoming "TRIPs compliant": • As mentioned earlier, TRIPs leaves substantial room for an implementation in a way which takes specific national policies and priorities into account. This flexibility is built into the TRIPs Agreement. Developing countries therefore should implement the TRIPs while truly taking into account Article 1.1 of the Agreement, which provides that members are free “to determine the appropriate method of implementing the provisions of this agreement within their own legal system and practice”. • Efforts related to the implementation of the TRIPs Agreement will not end by the end of the transitional periods, since part 3 of the TRIPs Agreement provides minimum standards for the enforcement of IPR protection. The workload and pressure on the legal system of developing countries, related to enforcement, will only begin after the end of the transitional periods. • Implementation will reach beyond the intellectual property offices, since the enforcement rules included in TRIPs may require the revision of national laws in respect of civil, criminal and administrative procedures as well as a revision of the role of police and customs authorities. Thus, TRIPs enforcement should be part of a wider approach which comprehensively strengthens the legal and law enforcement infrastructures. Page | 106

• A final important observation relates to post-TRIPs era: the legal structure of TRIPs emerged from and belongs to the legal and historical traditions of developed countries. In fact TRIPs has been described as reflecting the legal culture, paradigms and interests of industrialized nations. However often IP has been equated with TRIPs and it is important to make a distinction. IP does not have to be contradictory to the policy objectives of developing countries; in fact, some believe that increased protection of intellectual property rights may enhance the achievement of those objectives. The development IP rights which are of interest to developing countries, covering their knowledge base and information resources, may make IP a more positive discipline for these countries and can present an important aspect of sustaining the effectiveness and acceptance of IP systems worldwide. Specifically, a lot of interest has been expressed on the part of developing countries for standards providing for the protection of traditional medicine and know-how and biodiversity.

4.8 Technical issues 4.8.1 Patentability of pharmaceutical inventions The main rule relating to patentability is that patents shall be available for any invention, whether a product or a process, in all fields of technology, provided the invention meets the standard criteria for patentability - namely, novelty, inventive step and industrial applicability. In addition, countries are required to make the grant of a patent dependent on adequate disclosure of the invention and they may require information on the best mode for carrying it out. Disclosure is crucial, since it makes important technical information publicly available so that others may use it for advancing technology in the area, even during the patent term, and it ensures that, after the expiry of the patent term, the invention truly falls into the public domain. Three types of exception to the above rule on patentable subject-matter are allowed; these exceptions may be of interest from a public health perspective: • Inventions the revention of whose commercial exploitation is necessary to protect ordre public or morality, including to protect animal or plant life or health; • Diagnostic, therapeutic and surgical methods for the treatment of humans or animals; and • Certain plant and animal inventions. 4.8.2 The rights conferred and the term of protection According to TRIPs, the minimum rights that must be conferred by a patent follow closely those that were found in most patent laws, namely the right of the patent owner to prevent unauthorized persons from using the patented process and making, using, offering for sale, or importing 8 the patented product or a product obtained directly by the patented process. Under the TRIPs Agreement, protection must last for at least 20 years from the date of filing of the patent application. The WTO Panel in "Canada - Term of Patent Protection" recently found that this rule applied not only to new patents but also to patents in force at the end of a Member country's transition period. It should be noted that, although the issue of patent term extension to compensate for regulatory delays in the marketing of new pharmaceutical products was raised in the Uruguay Round negotiations, the TRIPs Agreement does not contain an obligation to introduce such extension.

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4.8.3 Limitations/exceptions to these rights Under the TRIPs Agreement, patent rights are not absolute but can be subject to the following limitations or exceptions: • Countries may make limited exceptions, provided that such exceptions do not unreasonably conflict with a normal exploitation of the patent and do not unreasonably prejudice the legitimate interests of the patent owner, taking into account the legitimate interests of third parties. Thus, for example, many countries allow third parties to use a patented invention for research purposes where the aim is to understand more fully the invention as a basis for advancing science and technology. The Bolar provision (see par. 3.5) is another example of an exception. • Countries may authorize the use by third parties (compulsory licenses) or for public non-commercial purposes (government use) without the authorization of the patent owner. Unlike what was sought by some countries in the negotiations, the grounds on which this can be done are not limited by the Agreement, but the Agreement contains a number of conditions that have to be met in order to safeguard the legitimate interests of the patent owner (see Article 31). Two of the main conditions are that, as a general rule, an effort must first have been made to obtain a voluntary license on reasonable commercial terms and that adequate remuneration shall be paid to the right holders. • Countries have the right to take measures, consistent with TRIPs provisions, against anti-competitive practices. When a practice has been determined after due process of law, to be anti-competitive, the conditions for issuing compulsory licenses are more flexible. For example, the two conditions specifically referred to above (regarding voluntary license and remuneration) may be relaxed. The Agreement also provides for consultation and cooperation between Member Countries in taking actions against anti-competitive practices. 4.8.4 Other policy instruments It should be remembered that governments may use public policy measures outside the field of intellectual property to address issues of access to and prices of drugs. For example, many countries use price or reimbursement controls. The TRIPs Agreement makes it clear that WTO Members may, in formulating or amending their rules and regulations, adopt measures necessary to protect public health and nutrition, provided that such measures are consistent with the provisions of the Agreement. Transition provisions The TRIPs Agreement lays down some rather complicated transition provisions which give countries periods of time to adapt their legislation and practices to their TRIPs obligations; these periods differ according to the type of obligation and the stage of development of the country concerned. With regard to the protection of pharmaceutical inventions, there are two situations. The basic rule is that developing countries have until the 1st January 2000 and least developed countries until 1 January 2006 to meet their obligations. A small number of developing countries, which did not grant patent protection for pharmaceutical products, have until 1st January 2005 to introduce such protection. However, from 1 January 1995, they have to provide a system where applications for pharmaceutical product patents can be filed (often referred to as a "mailbox" system). These applications do not have to be granted until after 1st January 2005. If found to be patentable by reference to their filing (or priority) date, a patent would have to be granted for the remainder of the patent term st

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counted from the date of filing. In the event that a pharmaceutical product that is the subject of a "mailbox" application obtains marketing approval prior to the decision on the grant of a patent, an exclusive marketing right of up to five years will have to be granted provided that certain conditions are met. TRIPs in context Most developing and least developed countries already grant patent protection for pharmaceutical products. In these countries, the TRIPs Agreement will therefore not lead to fundamental changes, although a certain amount of adjustment in legislation, for example in respect of patent term and compulsory licensing, may be necessary. With respect to the fairly limited number of countries that did not provide patent protection for pharmaceutical products at the time of entry into force of the WTO Agreement, some, including Brazil and Argentina, have decided to provide such protection more quickly than is required under the TRIPs Agreement. The TRIPs Agreement pays considerable attention to the need to find an appropriate balance between the interest of rights holders and users; this was an important theme in the negotiations. This is not only reflected in the basic underlying balance related to disclosure and providing an incentive for R&D, but also in the limitations and exceptions to rights that are permitted and in the transition provisions. Whether this balance has always been found in the right place is a question for discussion among WTO Members. The protection of pharmaceutical inventions is one aspect of much wider negotiations, covering not only the protection of intellectual property in general in a coherent and non-discriminatory way but also further liberalization and strengthening of the multilateral trading system as a whole. While it is true that some countries put particular emphasis on TRIPs matters in the Uruguay Round negotiations, it is also true that other countries attached great importance to other areas, for example textiles and agriculture. A strong and vibrant multilateral trading system is believed to be essential for creating conditions for economic growth and development worldwide. This, in turn, will generate the resources required to tackle health problems. 4.9 Standards for patentability TRIPs requires that patents are granted when the typical standards for patentability, that is, novelty, inventive step and industrial applicability, are met. But the Agreement does not specify how these criteria should be defined and applied. So there is room for WTO members to decide how to apply these criteria, in a strict way or in a very flexible way. Some countries apply these criteria in a very flexible way and, paradoxically perhaps, a good example is the US. An example is the novelty requirement. Usually, the novelty requirement means that a patent will not be granted if the invention has been disclosed anywhere in the world. This is the universal standard of novelty. Disclosure can take place through publication or through use (if an invention is used, it means the public knows it). These are the typical ways in which disclosure can destroy novelty, and therefore can destroy patentability. But the US has standards for novelty which are lower. Under US law, novelty is destroyed if an invention has been disclosed through publication or through use in the US. But outside the US, novelty will only be destroyed if the disclosure took place via publication. Novelty is not destroyed if disclosure was done through use of an invention outside the US. This is the reason why, in the US, patents have been granted, and this has created a lot of concern in developing countries, on traditional or indigenous knowledge, plants and genetic materials used for centuries in developing Page | 109

countries; the Indian Neem tree is one of the well known cases. Similarly, the way in which the inventive step requirement is applied, is very loose. This has drawn a lot of attention lately, because of a number of patents granted on so called business systems, for instance the “one-click� method for buying books by ecommerce. This has been patented and as a result no other company can use a system for ordering a product via the internet, based on only one click. Figure 28: Animal hat patent

Figure shows an example of a patent granted in the US in 1990, which is still in force: patent number 4,969,317 Animal Hat Apparatus and Method. There are many other examples of trivial inventions for which patents have been granted, and this has created considerable controversy. The patent in this example is not very significant, since it has little economic importance. But the same loose criteria are applied in other sectors, such as pharmaceuticals. When thinking about patents for pharmaceuticals, implicitly one thinks about new drugs, about new chemical entities (NCEs). Each year, only a limited number (less than 100) of NCEs are being developed. Yet thousands of pharmaceutical patents are being granted, since around most NCEs, there is a large number of patents which relate to processes, dosage forms, formulations etc. This creates a very difficult situation for companies which are interested in producing a generic version. Some concrete examples: • Processes: Ertythropoietin is a human protein, an important biotechnology based product. The first to sequence the gene that codifies for this protein was a US company, Amgen. But with 2-3 months time lag, another company, Genetics Institute (GI) also sequenced the gene and each claimed to be the inventor. In fact, it could be argued that the inventor was nature and that the companies just discovered it. However, in the US, a decision was taken in favor of Amgen, and as a result GI was unable to commercialize this product in the US. GI then applied for a number of process patents, not in the US, where it had lost, but in several developing countries in Latin America. So in Chili, Argentina, Mexico and some other countries, GI owns process patents related to ertythropoietin, on the basis of which it has tried to stop any production and commercialization of ertythropoietin. A process patent puts the burden Page | 110

of proof on the defendant, therefore, once the patent has been granted, it can be used aggressively to stop competition since there is an assumption of validity. Maybe the defendant can prove after 2-3 years (this is how long it usually takes) that he has the right to produce ertythropoietin, because the patent was invalid or because a different process is being used, but in the meantime the defending company may already have gone out of business. • Uses: Some countries are also issuing patents for new uses of a known product; e.g. the second indication for pharmaceuticals. An example is AZT. AZT was a known product but a new patent was granted for use in case of HIV infection. There was no real novelty, so it is under a fiction of novelty that such patents are granted. It is important for countries to consider whether they will grant patent protection for such new uses. • Polymorphs: Polymorphs are different crystals of the same molecule. So chemically, it is the same thing. Sometimes, the originator company asks for a new patent for a different polymorph; this may lead to an extension of the patent protection. A well-known case is cimetidine. SK-F obtained a patent for cimetidine and 4 or 5 years later applied for and obtained a patent on a polymorph, with which the patent protection would effectively have been extended for 4 to 5 years. In this particular example, the second patent was challenged and eventually invalidated, but this creates situations in which companies are forced to litigate. Due to such flexible application of patentability criteria, a growing number of patents are granted, which leads to over-protection. So while there is a role for the patent system to protect real inventions, the system should not be misused by granting patents for polymorphs, dosage forms, formulations, processes etc., which limit the scope for generic introduction and competition. Finally, it is important to realize that it is not relevant whether the secondary patents are strong; even if they are weak, big companies can use them aggressively against small, local or generic companies and stop competition, because litigations are cumbersome and costly. Therefore, defining the scope of patentability, including patentability of secondary inventions, is a very crucial issue. 4.10 Compulsory License A compulsory license is an authorization which is granted by the government without the permission of the patent holder. Most countries have provisions for compulsory licenses, either under their patent law or, as in the US, through anti-trust legislation. Under the TRIPs Agreement, countries have the right to issue such licenses. While the Agreement does not limit the grounds -or reasons- for granting compulsory licenses, countries can only use those grounds which are allowed by their national legislation. The development of appropriate national legislation is therefore crucial. TRIPs further states that the conditions under which a compulsory license is granted should be regulated in accordance with the TRIPs Agreement (Article 31). Grounds Countries have specified many different grounds for issuing compulsory licenses; these can include public health reasons. Other grounds are for instance emergency situations, epidemics, public non-commercial use, to remedy anti-competitive practices or to protect the environment; it is entirely up to the national law to decide which are the grounds, so there is a lot of flexibility. The German law, for example, simply states that compulsory licensing is allowed ‘for reasons of public interest’; a broad description that can be used in many situations. Under US law, compulsory Page | 111

licenses can be issued to remedy anti-competitive practices and for use by the Federal Government; both these grounds are used extensively for issuing such licenses. Conditions A compulsory license limits the rights of the patent holder, but does not take those rights away. TRIPs therefore specifies the conditions that need to be applied when countries want to grant a compulsory license. An important condition is that each case shall be considered individually. Also, in general, efforts should first be made to obtain a license from the patent holder (a so-called voluntary license), on reasonable terms. What is considered ‘reasonable’ depends on national (case) law. The conditions mentioned in TRIPs merit careful reading, and it is important to select carefully the wording when translating TRIPs into national legislation: • Remuneration for the patent holder shall take into account (not "be equal to" or "be based on") the economic value of the authorization. So if the contribution of a patent is minor, as for instance in case of a formulation patent, the royalty rate can be lower. Under US national law, compensation is based on what the patent holder has lost. In case of a CL to provide drugs to a population who would otherwise not be able to afford those drugs, it could be argued that the patent holder lost nothing. • In case of public non-commercial use or government use, TRIPs does not require countries to provide for the right of injunction, only for payment of compensation. Again, this is important for the actual implementation of a CL for public use. This is practiced in the US; the US Government cannot be sued for infringement of a patent, it can only be sued about the amount of compensation paid. Under US law, the same applies to contractors acting on behalf of the US Government. • A decision to issue a CL must be subject to review, but this does not have to be a judicial review; TRIPs only requires that the review is independent, so countries may opt for an administrative review, which is less burdensome and much faster. It seems advisable for developing countries to provide for an administrative review only, to prevent patent holders from blocking the use of a CL by initiating time-consuming court procedures. • A compulsory license shall be predominantly for the supply of the domestic market. A CL therefore would hardly interfere with practices of differential or tiered pricing. However, "predominantly" is not exclusively, so some export is still possible. Public interest groups advocate that export to a market where a CL has been issued, should be allowed; otherwise, countries with small markets, where local production is not viable, would not be able to use CL provisions effectively. • If a CL is issued to remedy anticompetitive practices, many of the conditions do not apply, such as the requirement to first try to obtain a voluntary license. Also, the restriction on export no longer applies; this is important for the US, which frequently issues compulsory licenses to remedy such practices. Main function At times, the fact that few such licenses have been granted is used as an argument against the compulsory license system. While it is true that in some countries, e.g. UK, few compulsory licenses have been issued, other countries, such as the US, have granted a large number of compulsory licenses. But regardless of whether or not they are used frequently, provisions for compulsory licensing are needed, because they will encourage the patent owner to behave correctly. They give a sign to the patent owner that in the case of abuse of rights and/or non-availability of the product, a third party could be allowed to use the invention; this prevents malpractice and misuse of the monopoly rights. In fact, one of the most important aspects of a compulsory license Page | 112

system is its impact on the actual behavior of the patent owner, therefore it is a necessary element in any IPR law. However, to ensure the system can be used effectively, it is important to carefully state the grounds and conditions for its use in the national legislation; these should include its use for reasons related to public health. 4.11 Parallel import Parallel importation refers to the importation, without authorization of the patent holder, into a country of a product from a third country, where this product has been marketed by the patent holder or in another legitimate manner. It is mainly used when the price in the third country is considerably lower than the price the patent holder charges in the country concerned. Parallel import is allowed under the TRIPs Agreement; in fact, TRIPs explicitly states that it does not address the issue of parallel import, thereby leaving countries free to determine their own policy in this respect. At times it is being argued that allowing parallel import in developing countries will result in an increase in counterfeit and/or substandard products in the market and will therefore have a negative impact on consumers. This is speculation. However the benefits are quite clear and there is a strong economic rationale for developing countries to adopt parallel import. A market where price discrimination is common, such as the pharmaceutical market where prices for the same product can vary considerably between countries, will fundamentally change if parallel import is allowed. The multinational pharmaceutical industry argues that parallel import will prevent preferential prices for developing countries. To the extend that developing countries do indeed benefit from preferential prices, this could be true. The drug companies’ worries are understandable since, obviously, revenues would come under pressure if ‘high-price markets’ such as the US would start parallel importation of cheaper drugs from, for instance, Canada. If this were to happen (in fact, currently there is considerable support in the US for allowing parallel import of drugs from Canada), companies would be tempted to react by harmonizing their prices across borders. The solution however seems to be to prevent parallel importation in industrialized countries, instead of putting pressure on developing countries in this respect. It is worth noting that the US legislation on IPR allows parallel importation; however, in the US, parallel import of medicines is forbidden by regulations related to Food and Drug Control.

4.12 Exceptions to the exclusive rights TRIPs Article 30 allows for limited exceptions to the rights conferred to the patent holder. These exceptions however can be challenged and subsequently reviewed by the WTO. In the context of pharmaceuticals, the most common exception to the exclusive rights of the patent holder is often referred to as the 'Bolar provision'. A Bolar provision allows interested (generic) manufacturers to start producing test batches of a product before the patent expires, in order to collect the necessary data for submission to the registration authorities; this will reduce the delay for generic products to enter the market after the patent has expired, and thereby enhance competition. The text of the TRIPs Agreement does not specifically address this issue. However, in a recent WTO dispute, a WTO Panel ruled that a provision in Canadian Page | 113

law, which permits the use of patented products by generic producers for the purposes of seeking regulatory approval from the authorities for the marketing of their generic version soon after the patent expires, is allowed under TRIPs. However, the Panel also decided that manufacturing and stockpiling of patented medicines by generic producers during the six months prior to the expiry of the patent term (which was also permitted under Canadian law) is not allowed. With this decision, the Panel effectively has decided that a 'Bolar type' provision is ‘TRIPs compliant', provided certain conditions are met. . 4.13 Roadblocks on the pharmaceutical competition highway: Strategies to delay generic competition 4.13.1 Introduction This Antitrust law and antitrust enforcement play a crucial role in assuring that consumers receive the benefits of a competitive marketplace. That is particularly true in generic pharmaceutical markets. In some respects generic pharmaceuticals are the model of a competitive market: there are numerous competitors and relatively limited barriers to entry. Generic pharmaceuticals are instrumental to health care in the United States and offer low cost and high quality to millions of consumers. The promise of generic drugs, however, is threatened by exclusionary conduct by dominant brand name firms. This section describes various types of exclusionary conduct and explains that without effective use of antitrust law to restrain exclusionary conduct by dominant firms the promise of generic competition may be diminished or forestalled. This section begins with a discussion of the importance of generic pharmaceuticals and preventing anticompetitive conduct that hampers generic entry. It then addresses how the pharmaceutical market is different from other types of markets and how the rules for dominant firm conduct should be adapted to those industry-specific factors. The article then addresses three types of ongoing anticompetitive conduct by dominant brand name firms: product line extensions, citizen petitions, and authorized generics. It closes with four suggestions for antitrust enforcement in order to assure that the competitive market for generics is protected from exclusionary conduct by dominant pharmaceutical companies. 4.13.2 The importance of generic competition It seems indisputable that competition from generic pharmaceutical manufacturers benefits every consumer. Generic drugs typically sell for approximately 70% less than their branded alternatives. Generic drugs are as safe and efficacious as branded drugs. Generic drugs account for over 56% of all prescriptions but only account for 13% of pharmaceutical expenditures. According to a CBO study in 1994 (when the rate of generic substitution was far lower), consumers in the U.S. saved $8-10 billion annually because of generic drugs. Generic drugs not only result in cost savings, but also enable more consumers to purchase safe essential drugs needed for their health and well being at the lowest price. ¶ Why is antitrust enforcement important to the emergence of generic drugs? Today consumers can purchase low-cost generic forms of Remeron, Relafen, Buspar, Taxol, Augmentin, Paxil, Lupron, Coumadin, and Platinol. For each of these drugs the branded company – a dominant firm – attempted to extend its patent monopoly Page | 114

through some form of alleged exclusionary conduct. In some cases the firms used questionable filings in the FDA orange book. In other cases they engaged in inequitable conduct before the Patent and Trademark Office. In other cases they engaged in sham litigation. In still other cases they found different ways to delay generic entry. In total, these drugs accounted for sales of over $10 billion a year before this anticompetitive conduct ceased. Thanks to the efforts of the Federal Trade Commission, state attorneys general, and private antitrust attorneys representing buyers of these drugs, antitrust litigation played a significant role in ending this anticompetitive conduct. Consumers save billions of dollars annually because of these enforcement efforts. Perhaps one sign of the importance of these cases is that the rate of generic substitution has increased from 44% to 56% in the past decade. Policing exclusionary conduct by dominant firms in the pharmaceutical industry could not be a greater priority. Unfortunately, the pharmaceutical industry offers many opportunities for dominant firms to manipulate a highly complex regulatory system to secure monopoly profits, not through superior foresight, industry and innovation, but by finding loopholes to delay competition. 4.13.3 Why pharmaceuticals are different • Regulation: Pharmaceuticals are heavily regulated. This regulation has a significant impact on entry and in turn, competition. No system of regulation is perfect, and regulation almost always offers the opportunity for competitive mischief. • Buyer Identity: Who is the buyer? Antitrust seeks to protect the interests of buyers and consumers, but assessing the identity of the buyer is quite complex in the pharmaceutical context. Is the ultimate buyer the consumer, the insurance company, the Pharmacy Benefit Manager, the physician who describes the drug or a combination of some or all of these? Determining the buyer is important in identifying competitive alternatives and defining the relevant market. It also may be important in determining which parties have standing to bring antitrust claims. • Costs: Pharmaceuticals typically have high fixed costs and very low incremental costs. The costs of manufacturing and marketing drugs are modest compared to the cost of development. • Distribution: Forms of distribution are complex Pharmaceuticals are distributed through numerous intermediaries. Not all distribution mechanisms are equally important and exclusion from some preferred mechanisms may pose especially significant concerns. What do these special factors suggest about the standards for single firm conduct in the pharmaceutical industry? The following factors counsel for a more careful antitrust analysis in three areas: • Deceptive Conduct: The regulatory setting suggests that antitrust enforcers and courts must be particularly attentive to the opportunities of dominant firms to engage in deceptive or sham conduct. In a setting where serial litigation or regulatory filings may be a particularly fruitful tactic to delay competition, the courts and enforcers must be increasingly skeptical of claims that such efforts were based on the merits. • Cost-Based Testing: The cost relationship means that cost-based tests for predatory conduct may often be misleading. In a situation where variable costs are small, using a cost-based test may not be instructive in attempting to identify exclusionary conduct. • Safe Harbors: The complexity of distribution suggests that antitrust courts and enforcers should be extremely careful about using safe harbors in pharmaceutical distribution cases. For example, often in exclusive dealing cases the courts will focus Page | 115

on the significance of a specific form of distribution in the entire market. However, not all forms of distribution are equally important. 4.13.4 New forms of anticompetitive conduct by dominants Thanks to the effective enforcement of antitrust laws, many forms of exclusionary conduct by dominant branded pharmaceutical manufacturers have been stopped. But new forms are arising. This section focuses on three varieties of conduct by dominant firms that may raise competitive concerns: product line extensions, questionable citizen petitions, and authorized generics. It is necessary to understand the incentives created by the pharmaceutical regulatory system to understand the nature of these practices. Patent laws and the HatchWaxman Act provide a period of exclusivity for brand name drugs during which there can be no competition. This period of exclusivity provides an important incentive for brand name firms to invent new drugs or improvements to existing drugs. Toward the end of a patent's life, the patent-holding firm faces the loss of a significant revenue stream. The expectation is that once a patent has elapsed, or a generic firm has developed a non-infringing version of the drug (or the patent is declared invalid), generic entry will occur. As described below, however, there are several types of exclusionary conduct that the patent-holding firm may engage in to delay or dampen the effect of generic entry. When dominant firms face the threat of new entry they often turn to strategic conduct to hold rivals at bay. Facing the inevitable decrease in market share (and consequent decline in sales revenue) that follows the loss of patent protection and introduction of generics, brand name drug manufacturers increasingly have turned to underhanded means to delay competition. Product line extensions Innovation is the lifeblood of the pharmaceutical industry and advances in drug technology mean that a growing number of medical conditions can be treated more effectively and safely. Moreover, advances can often improve the mechanism of delivery, dosage forms, and the method of interaction. Product line extensions are common in almost every industry, as we can tell from the numerous products advertised as “new and improved.” On the other hand, sometimes a product line extension has anticompetitive effects, especially when it is coupled with additional conduct to create barriers to generic entry. The FTC recognized this potential for anticompetitive conduct in its investigation of the merger of Cima and Cephalon. In that case, Cephalon manufactured a drug to help alleviate pain after cancer treatments. Cima was developing a similar drug. The merger raised competitive concerns in part because of the FTC’s belief that if the merger was consummated the Cephalon drug, whose patent was about to expire, would be removed from the market. As the FTC observed, “Cephalon’s ownership of both products will allow it to undermine generic entry by shifting patients [to the Cima product] prior to generic launch, depriving consumers of the full benefits of generic competition.” Without the Cephalon drug in the market, generic entry would be deterred. In order to avoid these potential anticompetitive effects, the FTC required Cephalon to enter into a licensing agreement to facilitate generic entry.

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Perhaps the most prominent case in this area is Abbott Labs. v. Teva, involving antitrust claims by Teva, Impax, and several groups of buyers alleging that Abbott’s changes to the drug Tricor violated Section 1 and 2 of the Sherman Act. Tricor is a drug used to lower cholesterol with sales nearing one billion dollars. Teva and Impax battled for several years, challenging Abbott’s patents over the capsule version of Tricor. According to their allegations, they prevailed on all their patent claims and were poised to enter the market in 2003. Then Abbott changed the product from a capsule to a tablet version, suggesting that the tablet version did not have to be taken with food, among other improvements. Further patent litigation ensued, and again Impax and Teva prevailed. Abbott did not just change their product. After the FDA approved the tablet formulation, Abbott stopped selling Tricor capsules and also bought back all the existing supplies of those capsules from pharmacies. In addition, Abbott changed the code for Tricor capsules in the National Drug Data File (“NDDF”) to “obsolete.” Changing the code to “obsolete” removed the Tricor capsule drug formulation from the NDDF, preventing pharmacies from filling Tricor prescriptions with a generic capsule formulation. Teva, Impax, and certain buyers of the drugs brought an antitrust suit challenging Abbott’s conduct. The defendants filed a motion to dismiss that was rejected. The court began by observing the difficult task of analyzing a product innovation claim: Because, speaking generally, innovation inflicts a natural and lawful harm on competitors, a court faces a difficult task when trying to distinguish harm that results from anticompetitive conduct from harm that results from innovative competition. ‘The error costs of punishing technological change are rather high and courts should not condemn a product change, therefore, unless they are relatively confident that the conduct in question is anticompetitive. If consumers are free to choose among products, then the success of a new product in the marketplace reflects consumer choice, and ‘antitrust should not intervene when an invention pleases customers.' The defendants argued that in order to prevail the plaintiff would have to demonstrate that “the innovator knew before introducing the improvement into the market that it was absolutely no better than the prior version, and that the only purpose of the innovation was to eliminate the complementary product of a rival.” The defendants fundamentally claimed that any product improvement would be per se legal. The court, however, rejected the claim. Rather than adopting the rule of per se legality suggested by the defendants, the court stated that the rule of reason balancing approach of the D.C. Circuit in US v. Microsoft was appropriate: The nature of the pharmaceutical drug market, as described in Plaintiffs' allegations, persuades me that the rule of reason approach should be applied here as well. The per se standard proposed by Defendants presupposes an open market where the merits of any new product can be tested by unfettered consumer choice. But here, according to Plaintiffs, consumers were not presented with a choice between fenofibrate formulations. Instead, Defendants allegedly prevented such a choice by removing the old formulations from the market while introducing new formulations. Hence, an inquiry into the effect of Defendants' formulation changes, following the rule of reason approach, is justified. Here the critical element was the conduct Abbott engaged in that limited consumer choice. The removal of the product from the NDDF and the withdrawal of the product were critical, since these actions prevented generic substitution. The defendants argued that this conduct was not an antitrust violation because a monopolist does not have any duty to assist its competitors. The court disagreed: a monopolist is not free Page | 117

to take certain actions that a company in a competitive (or even oligopolistic) market may take, because there is no market constraint on a monopolist's behavior…. Contrary to Defendants' assertion, Plaintiffs allege harm to competition rather than simply harm to Teva and Impax. By removing the old products from the market and changing the NDDF code, Defendants allegedly suppressed competition by blocking the introduction of Generic fenofibrate. In some respects the Tricor case is similar to the Losec case pursued by the European Union and Canada against AstraZeneca for making patent filings after patent expiration to delay generic competition. In Canada, when the patent for Losec expired, AstraZeneca applied for two new patents with respect to the product, but did not incorporate this new technology into any of its products. It also withdrew the additional product from the market. When the generic manufacturer in Canada, Apotex, sought to produce the drug on which the patent had expired, AstraZeneca challenged its entry because Apotex failed to secure approval on the two new patents. Late last year AstraZeneca was found to have violated the Canadian Competition Act. In the EU, AstraZeneca was fined 60 million Euro for similar conduct; that decision is on appeal to the Court of First Instance. A more recent case in the United States was filed by several groups of drug buyers against AstraZeneca for anticompetitive conduct involving the conversion of the drug Prilosec to Nexium just as Prilosec was losing its patent protection. The suit alleged that the “expensive, unnecessary and fraudulent conversion was undertaken solely in order to thwart and impede generic competition and thereby maintain defendants’ dominant position.” The suit claimed that AstraZeneca’s conversion of the market from Prilosec to Nexium forced drug purchasers to pay more than $2 billion in increased drug costs since December 2002. The specific alleged anticompetitive conduct included the following: • Up to 18 months before AstraZeneca was going to lose exclusivity for Prilosec, it stopped promoting about the drug’s effectiveness. • While creating and marketing Nexium, the company also effectively withdrew Prilosec from the market, causing managed care organizations to not cover the cost of its generic. • AstraZeneca marketed Nexium by saying it was superior to Prilosec, but to obtain FDA approval, it assured the FDA that it would not say that Nexium was better. In reality, it was essentially the same product. Citizen petitions The court system and the regulatory process can be used as tools to delay the entry or expansion of rivals to dominant firms. One of the most effective ways for parties to acquire or maintain market power is through the abuse of government processes. The cost to the party engaging in such abuse typically is minimal, while the anticompetitive effects resulting from such abuse often are significant and durable.” Anticompetitive conduct through regulatory abuse can be especially pernicious. When a firm acquires a dominant position through competition in the marketplace, we can expect other competitors to arise and possibly displace them. No natural competitive force, however, can displace dominance acquired through abuse of the regulatory process. Page | 118

That is especially the case in the pharmaceutical industry, where litigation and regulatory approval are necessary for market entry. Not surprisingly, some of the most prominent government enforcement actions against dominant firms have involved all abuse of the regulatory process. One example of this regulatory abuse is sham orange book filings, such as the FTC cases involving Buspar and Tiazac and the State Attorney General case involving Remeron. These cases, and similar cases brought by private plaintiffs, have saved consumers hundreds of millions of dollars. One example involves the drug Coumadin, which is used by millions of Americans for blood-clotting disorders. In the mid- 1990s, faced with the anticipated threat of generic entry, Coumadin's manufacturer engaged on a multifaceted course of conduct to raise questions about the safety and bioequivalence of the generic drug, petitioning the FDA, the U.S. Pharmacopeia Convention, Inc. (“USP”), state legislators and state regulatory bodies and engaging in an alleged misleading advertising campaign. None of the petitions succeeded. The purpose of these efforts was to delay generic entry. These practices ceased after antitrust litigation brought by the generic manufacturer and groups of buyers. Almost 30 years ago, Judge Robert H. Bork observed that “predation by abuse of governmental procedures, including administrative and judicial processes, presents an increasingly dangerous threat to competition.” No statement could be more on point for anticompetitive conduct in the pharmaceutical industry and the practice of socalled “citizen petitions.” The FDA, like other regulatory agencies, allows the public to petition the agency using ‘citizen petitions.” Citizen petitions can provide an opportunity for individuals to express their concerns about safety, scientific, or legal issues regarding a product anytime before its market entry. Often these public challenges are genuine and legitimate. Increasingly, pharmaceutical companies have been exploiting the citizen petition process by filing baseless and redundant petitions in an effort to delay FDA approval of generic drugs. As one generic drug executive has observed in Senate testimony: Frequently, a brand company will file a frivolous petition on the eve of FDA approval of a generic equivalent. This despite the fact that the FDA may have already granted a tentative approval, meaning that FDA already determined the generic product is safe and effective. The brand strategy is that it will take several months for the FDA to decide the petition, during which time approval of the generic drug is held in limbo. The brand is not required to submit petitions with merit. What the brand company can do is block competition for several months beyond the life of the 20-year patent, thereby extending its monopoly on the market. In order to slow the approval process, citizen petitions are often submitted on the eve of the completion of the FDA review, which is when the brand company’s patent expires. These petitions are often based on information available well before the petitions are submitted. The citizen petition approval process is time-consuming. Despite tentative approval of the generic drug, it could take several months for the FDA to respond to a petition. The qualified generic is held in administrative limbo. Consumers suffer as lower cost alternatives are kept off the market. The FDA citizen petition process provides significant opportunities for deception. There are no requirements for proof of the accusations made in a petition; no requirements for certifications to the accuracy of the information; penalties for inaccurate or improper filings; and there are no limits on how many petitions can be filed. Multiple citizen petitions can be filed during the review process of a single Page | 119

generic drug. Often petitions are filed over an extended period of time, in an effort to extend the review process as long as possible. Some petitions contain little or no evidence and rely on obsolete, irrelevant, or erroneous information. Filers even submit the same petitions again after they have already been denied. The FDA has cited incidents in which citizen petitions have been used for improper purposes. FDA Chief Counsel Sheldon Bradshaw has acknowledged that he had seen “several examples” of citizen petitions seemingly designed to delay approval of generic drugs. According to the FDA, it is rare that petitions present new issues that the FDA has not already considered. The Office of Generic Drugs denies a high percentage of the petitions that it receives and few have ever altered FDA policies towards generic drugs. Dale Conner, the Director of the Division of Bioequivalence at the FDA Office of Generic Drugs, claims that most petitions are rejected because they are baseless: “Most of the time their motivation is simply to make it harder for the competition to come to market.” Perhaps the most critical factor in evaluating this practice is the impact of the petitions. The reality is that a trivial portion of the petitions are accepted by the FDA and found to require further action. Since the Medicare Modernization Act of 2003, brand companies have filed 45 separate citizen petitions requesting that the FDA delay the approval of a generic drug. Of these 45 petitions, the FDA has ruled on 21, of which they denied 20, or 95%. Eleven of the 21 petitions were “last minute petitions” filed within four months of the generic drug’s scheduled entry into the market. None of these last minute petitions were approved, but on average they caused delays of an average of 10 months. In one case, for each day that the petition delayed generic drug entry, the brand company gained an estimated $7 million. Obviously this is an attractive mechanism to delay generic entry. Not surprisingly, there has been a substantial increase in citizen petitions. The FDA Center for Drug Evaluation and Research (CDER) recorded an almost a 50% increase in the number of citizen petitions it received from 2003 to 2004. As of July 2006, there were about 170 citizen petitions pending compared to 90 in 1999. Defenders of the citizen petition process would suggest that these petitions are immune (or per se legal) under the Noerr- Pennington doctrine. Although the doctrine protects a wide variety of legitimate petitioning, certain types of sham petitioning are not immune. The FTC’s recent report on the Noerr-Pennington doctrine properly identifies limits to that immunity. Both courts and antitrust enforcers should recognize the pernicious effects of petitioning on generic entry. Authorized generics Another practice that may raise competitive concerns is the creation of so-called “authorized generics,” in which a branded company introduces a generic version of its own patented drug a short time before patent expiration. The “authorized” or “branded” generic undercuts the inevitable market penetration and profitability of the other would-be generic competitors by capturing a large part of the generic market prior to the entry of traditional generics. In some cases the innovator firm has entered with its own version of a quasi-generic. In other cases it has entered into arrangements with traditional generic firms to enter with a quasi-generic version of the drug. One must wonder why any branded firm enters with a generic version of a high value product. After all, we do not see Apple coming up with lower cost knock offs of an iPod. How is it in the economic interest of the branded firm to genericize a market? It can only make sense if the branded firm sees some long term benefit, such as diminished generic competition. ¶ Page | 120

The purpose of this strategy may be to diminish the incentive for generic entry. Just as patent law created a system of rewards to provide incentives to innovate, the HatchWaxman Act created a system to reward generics for creating non-infringing versions of a drug or successfully challenging patents. One of the key aspects of the HatchWaxman Act is a 180-day period of market exclusivity which is granted to the first firm to successfully challenge a patent on an innovator drug. During that 180-day period of exclusivity, the successful challenger is the sole generic firm; as such, it reaps substantial profits. Once the exclusivity period expires, numerous other generic firms enter and quickly force prices down to marginal cost. This exclusivity is essential to the balance of the Hatch-Waxman Act. Inventing noninfringing drugs is risky, time-consuming and costly. The regulatory system effectively requires patent litigation in order to enter the market and this litigation is a multi-million dollar proposition. But for the potential reward of six months of exclusivity which represents the vast majority of potential profits from generic entry, many firms might forego their efforts to challenge patents. ¶ One can see the potential effect of an authorized generic strategy. With the authorized generic coming to market prior to the entry of the generic firm that has marketing exclusivity, the value of that exclusivity may decrease substantially. As the value of the exclusivity decreases, generic companies will lose part of their incentives to enter markets by challenging invalid patents or developing non-infringing versions of the drug. In turn, consumers are deprived of the benefits of that generic competition. Is the reduction of these generic incentives sufficiently significant to have an anticompetitive effect? Perhaps so. As FTC Commissioner Jon Leibowitz has observed, “For some blockbuster drugs, the pot of gold will still be large enough so that some generics will fight to be the first to file and the first to market. But we could very well see fewer generic applications for smaller drugs—the ones that warrant several hundred million dollars a year in revenue—and this could lead to fewer generic products on the market which would be bad for consumers.” What are the potential antitrust concerns raised via an authorized generic strategy? Obviously, the issue poses a difficult and challenging antitrust issue. There is a battle between the apparent short-term benefits of having a new product come to market sooner and the potential long term harm of reducing the incentive and perhaps the ability of generic firms to effectively challenge patents and enter the market. Elimination or the reduction of the rewards from the 180-day exclusivity period, generic firms might just decide not to enter these markets. In other cases, the generic firms may decide not to challenge certain patents if the opportunity for success and the potential rewards do not seem sufficiently significant. ¶Understandably, the branded firms are not interested in aggressive competition that may threaten to cannibalize their sales. Could such a strategy be successful? There is an interesting historical example. After World War II, cigarette manufacturers faced the increasing threat of black label or generic cigarettes. In response to the emergence of these black label cigarettes, the branded manufacturers came out with their own black label cigarettes. They priced these black label cigarettes in a predatory fashion and eventually drove the independent private label manufacturers out of the market. Once these manufacturers were driven out, the cigarette manufacturers eliminated black label cigarettes and significantly increased branded prices. Ultimately this was challenged by the Justice Department in a successful antitrust case against the cigarette industry. Another potential competitive concern is that a manufacturer may develop a reputation for introducing authorized generics when entry by “true” generic competitors seems Page | 121

likely. This type of strategic conduct will not immediately foreclose competition, but it may well diminish competition in the long term by signaling to generic manufacturers not to attempt to enter the market. Thus, by diminishing the incentives for generic firms to challenge their patents, brand-name manufacturers could effectively raise the barriers to entry. ¶As a recent economic study sponsored by the Generic Pharmaceutical Association found: When authorized generics enter during the exclusivity period, this statutory incentive for generic companies to challenge patents and to develop non-infringing products is severely compromised. If the authorized generic captures half the sales in the generic market, the reward to the generic company that successfully challenged the patents or discovered a noninfringing product will be reduced by much more than half. If the incentive to challenge patents and develop non-infringing products is severely reduced, then generic companies will respond by investing less in those areas. This means that there will inevitably be fewer challenges even to patents which appear to be relatively weak. This could easily result in delays of several months or even longer in the arrival of generic competition. The ultimate losers from such delays, of course, are consumers, who will end up paying monopoly prices longer than necessary. Finally, the threat of a patent holder entering into an authorized generic agreement may compel generic challengers to drop their patent challenges and enter into settlements. The generic challenger knows that even if it is successful, the patent holder actually controls the conditions of entry. The incentive to aggressively litigate against a potentially invalid patent or invent around the patent will be dampened severely. The goal no longer will be to be the first to successfully challenge a patent, but rather be the first to enter into an alliance with the patent holder. Conclusion Antitrust plays a vital role in maintaining rivalry as the lodestar of the marketplace. Competition is critically important. Many of the factors identified earlier, however, may forestall competition. The FTC, state attorneys general, and private antitrust lawyers have played an important role in protecting pharmaceutical markets from artificial barriers to competition, but there is more to do. I suggest the following as an enforcement agenda: • The FTC should investigate a product line extension case. The competitive issues raised by product line extensions are addressed above. One of the most difficult issues in a product extension case is whether the new product is truly an improvement over the current product or merely an attempt to extend an expiring patent. The FTC may be more capable of addressing issues of product improvement because of the administrative litigation setting and the expertise of the Commission in pharmaceuticals. The Commission demonstrated this ability to grapple with complex technical issues in its recent Rambus decision. • The FTC should investigate a citizen petition case. Citizen petitions may be a particularly pernicious form of regulatory abuse. Because of the Commission’s expertise in the Noerr-Pennington doctrine from both the FTC study and its enforcement action against Unocal, the FTC is uniquely suited to handle the issues surrounding the allegations involving sham petitioning. The Commission’s recent enforcement action against Unocal for sham and deceptive conduct before state regulators has saved consumers over $500 million annually. The Commission should use that litigation expertise to address sham and deceptive petitioning in the pharmaceutical industry where there may be similar competitive harm. Page | 122

• The FTC should participate as amici curiae in pharmaceutical antitrust cases in the district courts to clarify key legal principles. Perhaps one of the most important actions as amici was the FTC brief in the Bristol Myers case that clarified for the court that sham orange book filings were not protected by the Noerr doctrine because they were merely “ministerial” filings. • Finally, the FTC and the Antitrust Division should be extremely cautious about articulating broad pronouncements in amicus filings in monopolization cases on the standards for exclusionary conduct. As suggested above, there are numerous economic factors affecting the pharmaceutical industry which would make such broad standards harmful to effective antitrust enforcement. 4.14 IPR in the Indian context The origins of the pharmaceutical industry in India can be traced back to the colonial (pre-independence) era. But right from its origin through the decades of the 1950s and 1960s, the industry remained largely dominated by foreign firms and drug prices were among the highest in the world. The decade of the 1970s has been of great importance to the IPR, which witnessed a “process revolution” through concerted effort at acquisition of technological capability fostered by a favourable policy environment, especially a weak patent regime. Through the decades of 1970s and 1980s, the IPR reached new heights of process capabilities to “knock off” any new drug with a noninfringing process and market them at low prices. At the present juncture, however, the industry is again at a watershed, trying to cope with the challenges of globalisation and reforms. It is going through a turbulent phase of adjustment driven by the emerging international economic order of the WTO, especially the TRIPS agreement establishing a new IPR environment. Process revolution in Indian pharmaceuticals post 1970 1970 marked the beginning of a new era for the pharmaceutical industry in India. With the introduction of the Patent Act 1970, there was a concerted effort at generating indigenous technological capability (in production as well as in research) in the pharmaceutical sector with the goal of increasing access to drugs at affordable costs. In fact the decade of 1970s witnessed the passage of several government directives directly shaping the growth path of this sector, including the Drug Price Control Orders (DPCO) 1970 and 1979, Foreign Exchange Regulation Act (FERA) of 1973, New Drug Policy 1978 and of course, the Patent Act 1970. A brief discussion of these policies may be in order. The Patent Act 1970 was a radical departure from the earlier Patent Law which accorded product as well as process patent protection up to a period of 10 years (extendable by another 6 years) and acted as a major deterrent to the creation of indigenous technological capability especially through reverse engineering. 1970 Patent Act, by contrast granted only process patent for chemical substances including pharmaceuticals, reduced the duration of patents to 7 years from the date of filing or 5 years from the date of sealing whichever is lower, excluded all imported substances from the domain of patent protection (i.e. only new substances manufactured in India were entitled to patent protection), and placed the burden of proof on the plaintiff in case of infringement. DPCO 1970 was the first concerted and rational effort to check the ever rising drug prices in India. DPCO 1979 expanded the coverage of drug price control, bringing about 80% of the Indian pharmaceutical industry (in value terms) under price regulation. The price fixing rules were made more rigid and stringent. Page | 123

FERA 1973 was introduced to restrict and regulate the operations of foreign (multinational) companies in India to protect and develop indigenous industrial and technological capability. A 40% ceiling was imposed on foreign equity share, with the exception of “Core� sectors (including pharmaceuticals), where up to 74% foreign equity was allowed to high technology bulk and formulation producers provided their 50% of the bulk is supplied to non-associated formulators and the share of own bulk in their formulation should not exceed 1/5. The spirit of this policy regime of the 1970s was reinforced by Drug Policy 1978 with its three-fold objective of self reliance in pharmaceutical technology, self sufficiency in drug production and easy and cheap availability of drugs. This in a sense summarises the policy framework adopted in the 1970s with a clear emphasis on import substitution and self-reliance in the production of bulk as well as formulations and on creating indigenous technological capability of process development (bulk). Against the backdrop of this policy environment, the pharmaceutical industry in India embarked on a new trajectory of technological learning based on reverse engineering, which essentially implies decoding an original process for producing a bulk drug. This involves a detailed understanding of the chemical properties of the active molecule, the excipients used and the chemical process of conversion from the active molecular compound to the final bulk drug. A chemical process incorporates a complex set of parameters, e.g., solvent conditions, temperature, time, stirring methods, use of various chemical and physical substances with different levels of purity etc., all of which have to be simultaneously optimised in order to arrive at the optimum process specification. It is possible to decode all of these parametric specifications of a process through reverse engineering. One can make a distinction between two types of reverse engineering activities: infringing and non-infringing processes. In case of the former, a reverse engineered process exactly matches the specifications and design of the original process and therefore, needless to mention, the use of such processes infringes upon the intellectual property rights of the innovator of the original process. Hence the scope of such activities is limited to off-patent drugs only. The second category of reverse engineering activities is somewhat more complex as it results in the development of non-infringing processes whereby the same bulk drug may be produced through a different route. Non-infringing processes are relevant only in case of patented drugs, which may be free from product patents but continue to enjoy process patent protection. With the introduction of the Patent Act of 1970, there has been widespread reverse engineering for non-infringing processes. This is not to suggest that infringing process development (simple imitation) did not take place. In fact many of the firms began with such simple technological activities (perhaps on off-patent drugs) to acquire more complex capabilities at a later stage. Indeed, the industry acquired substantial technological capability of process development through reverse engineering, both infringing processes for off-patented molecules and noninfringing processes for patented molecules. This phenomenon has been often been referred to as the process revolution in the Indian pharmaceutical sector. As a result, the bulk drug industry grew at a phenomenally high rate of 21 and 11% p.a. during the decades of 1970s and 1980s respectively. Along with process revolution, simple product development in conventional dosage forms which had already started in the post independence era, continued in the post 1970s. As a result, the formulation industry also registered impressive growth rates of 13 and 10% p.a. respectively during the same periods. The impetus largely came from the massive expansion of bulk drugs due to the process revolution and the policies to deter captive consumption of bulk. Indeed there was a marked increase in R&D expenditure of the industry Page | 124

during this period: it stood at Rs 500 million in 1986 accounting for nearly 2% of the industry’s sales turnover compared to less than 1% prior to 1970. The policy environment facilitated free entry of a large number of producers of both bulk and formulation, most of them in the small scale and unorganised sector. The resultant market structure was characterised by a limited number of large organised sector units enjoying the lion’s share of the market on one hand and a very large number (thousands) of small producers each producing a microscopic fraction of the total industry sales. This implied a wide variation in the quality and price of a drug in the market and multiplicity of formulations. Problems of spurious drugs and irrational combinations have been a natural outcome of this phenomenon. While the policy environment favoured small producers, lack of adequate quality regulations and control mechanisms often resulted in the supply of sub-optimal and ineffective drugs. Apart from deviations from the quality norms, the norm itself was often kept at a low level by the regulatory authority to encourage small producers who may not be able to afford sophisticated equipments for various tests/ assays. Indeed there has been a noticeable difference in the parameters of acceptable drug quality in India compared to that of the developed world. But most drugs were now available in India at affordable prices, the quality variations notwithstanding. As an outcome of the policy framework, MNCs became reluctant to launch their new drugs in India. But that did not deprive the Indian patients from the latest drug discoveries without much delay in launching. Indian firms introduced these new drugs in the market using noninfringing processes, perhaps with a time lag marginally exceeding the demand lag. Examples are numerous: Ranitidine (Glaxo) and Amlodipine (Pfizer) are two of the glaring examples of this phenomenon. The new world order post-1990: India’s reforms process In tune with a newly emerging international economic order, India’s economic reforms process began in the late 1980s/1990. WTO has been the prime architect of the broad framework of this new global order, primarily geared towards free trade and removal of “policy distortions” in all dimensions of a country’s economic activity. The idea is to pave the way for liberalised and market driven international flows of goods, services, capital and technology in a multilateral framework. Ironically, however, one also finds provisions for bilateral negotiations and unilateral actions built into the WTO framework, especially when it serves the interest of developed countries. Product regulations and standards, antidumping and other safeguard measures are examples of WTO provisions which can be misused (mainly by the developed nations) to counter the spirit of multilateral trade liberalisation propagated by the WTO and the proponents of this new world order. India’s reform process began with trade reforms which sought to reduce, rationalise and eventually eliminate all forms of trade restrictions, tariffs, export import licenses, quantitative restrictions and other non-tariff barriers. Reduction and removal of subsidies have accompanied trade reforms in India. Policies towards foreign investment and foreign technologies have been relaxed. FERA 1973 was modified to Foreign Exchange Management Act (FEMA) 1999. The monitoring of payments for imported raw material, and technical know-how was deregulated, but RBI retained the monitoring authority of the dividend payment. FEMA allows the pharmaceutical MNCs to hike their stakes in India up to 74%. Automatic approval can be granted for foreign technology agreements in high priority industries up to a lump sum payment of Rs.10 m, or if the royalty is less than 5% of domestic sales or 8% of exports, subject to a Page | 125

maximum ceiling. For other non-high priority industries automatic permission will be given according to the same guidelines if no free foreign exchange is required for any payments. The Patent Act of 2005 has been direct fallout of the WTO agreements. The salient features of the forthcoming patent regime are summarised below. • Product patents are allowed in all fields of technology with a uniform duration of 20 years in pharmaceuticals, food products and agrochemical from the date of application. • Compulsory licenses will be given by the government only on the merit of each case, and would be granted in case of national emergency. However, the patent holder will be given a hearing and an opportunity to present his case for intellectual protection. • There will be no discrimination between imported and domestic goods in so far as intellectual property protection is concerned as per the national treatment clause in WTO. • For process patents, the burden of proof will rest with the party that infringes. This is in contrast with the requirement of the earlier patent regime. In Patent Act of 1970 burden of proof was on the original innovator. With the enactment of this law, the policy framework encouraging process development through reverse engineering activities disappears. But the strong product regime is “supposed” to encourage basic and frontier research in the industry. Other elements of the structural adjustments programme followed by India include industrial reforms leading to abolition of industrial licensing, virtual elimination of MRTP regulations, divestment of public sector units and de-reservation and reduction of benefits of the small-scale sector. Among the specific policy initiatives towards the pharmaceutical sector, DPCO 1987 followed by DPCO 1995 appeared as major landmarks reinforcing the policy move towards liberalisation. Both of these policies aimed at progressive decontrol of drug prices. It is interesting to note the clear policy shift in the stated principle for controlling drug prices. As opposed to the earlier objective of making drugs available at affordable prices, the DPCO 1995 clearly states that the objective is to prevent monopoly in any market segment. Only 40% of the total finished dosage forms remain under price control in 2001 compared to 85-90% in 1979. The overall philosophy of the new policy regime is well echoed in the Drug Policy Statements of 1986, 1994 and 2003. Licensing requirements for all bulk drugs and formulations are abolished with a few noted exceptions. Restrictions on import of bulk are largely removed. The earlier policy to deter captive consumption of bulk is reversed. Major thrust is placed on drug quality, acknowledging the need to monitor and regulate quality and promote rational use of drugs. It stresses the need to implement Good Manufacturing Practices (GMP) for all manufacturing units. Although the IPR has continued to expand both in terms of production and trade during the decade of the 1990s, the new policy environment has posed major challenges to the sector which is evident from rising drug prices, downsizing of employment and closure of production facilities of many units including that of multinationals. As a result, the IPR is going through a turbulent phase of adjustments. In the following section, we attempt to trace this adjustment process for the organised segment of the industry. Challenges and adjustments post 1990: quality and R&D as the Twin Pillars The challenges The major challenges posed by the new policy regime of globalisation and reforms to the Indian pharmaceutical industry, especially those in the organised sector can be synthesised as follows. Page | 126

• Limits to growth through process development- With the introduction of the new patent regime, the conventional corporate growth strategy, based on non-infringing process development for patented molecules to introduce the latest drugs in the Indian market, adopted by the IPR till now, will no longer be a viable option. Reverse engineering on patented drugs will come to complete halt, raising a big question mark as to how far the Indian pharmaceutical can exploit its process development capabilities acquired through conscious R&D effort during the last quarter of the century. Reverse engineering on off-patent drugs can, of course, continue to give them an edge in the generic market. In fact a market of about US$50b of pharmaceutical products will come off-patent in the next few years. • Limits to the generic market - Given that new drugs will now become the exclusive monopoly of the innovating firm, we believe that the generic market will become extremely crowded both in India and the world since all non-innovating firms will have to rely on the generic market. A further limit on the scope of business development based on the generic market may be posed by the high rate of new drug discovery in the 1990s. Since most these new drugs are not “new” in the sense of having a pioneering therapeutic use, but are merely replacing existing drugs with better therapeutic efficacy and lower side effects, new drug discovery might reduce the life span of existing drugs. This in turn implies a high rate of obsolescence in the generic pharmaceutical market. The global pharmaceutical market is becoming increasingly competitive both with respect to price as well as quality. Even with trade liberalisation, the WTO allows for imposition of product regulations and standards to create barriers to free flow of trade. This is being fully exploited by the developed countries to protect their large pharmaceutical markets from low cost imports from the developing world. Therefore new norms of drug quality are being introduced worldwide which will further limit the scope of access to the world generic market. With a move towards quality harmonisation, drug quality will act as a principal parameter of success even for Indian firms in years to come. The adjustments To cope with these serious challenges, the Indian industry (organised sector) is going through a major phase of restructuring and adjustments. Let us analyse and capture some of these. We restrict our analysis to two of the major dimensions of the adjustment process. The first relates to the response of the Indian industry to a new paradigm of drug quality. The second looks at the changing role of R&D and technology in this new era of globalisation and reforms. A new paradigm of drug quality Drug quality is a complex multi-dimensional concept. First and foremost, quality implies therapeutic efficacy and safety. A high quality drug must be effective and should not produce any toxicity or side effects. In this regard, bio-availability acts as an important parameter of drug quality. A second and most commonly stated parameter of quality pertains to the impurity profile and stability of chemical ingredients. A related quality parameter affecting product purity is contamination during the production process. Not only keeping minimum impurity is important, but also consistency in the specified impurity profile over all batches of production must be adhered to. Detailed documentation of all the production stages along with the quality control operations constitutes an added dimension of quality specification as it creates institutional memory and makes the entire production process transparent to all concerned parties. The third set of quality parameters stipulates that the production process should be environment friendly and Page | 127

should not create any health hazards within and outside the production unit. The intermediates and excipients of the production process must also be non-hazardous and environment-friendly. The relative importance of each of these diverse parameters in the final quality specification would vary from country to country depending on the composition of their pharmacopoeial committee and socio-economic priorities of the government. This has resulted in divergence of the technical requirements for quality specification and control in different countries, compelling the globalised industry to replicate many test procedures including clinical trials in order to market new products in different countries. To overcome this problem, the governments of the three largest pharmaceutical markets (United States, Europe, and Japan) have jointly initiated a move towards harmonisation of drug quality through the International Conference on Harmonisation (ICH) from the late 1980s. The US Pharmacopoeia (USP) has dominated this harmonisation movement with an in-built bias towards increasingly stringent norms for impurity profile through sophisticated instrumentation and analytical methods. Prior to the 1990s, drug quality in India was loosely defined and remained far below international standards. This is not to suggest that there were no high quality producers even during this period. But quality parameters did not receive much attention by the industry and the regulatory authorities in general. But in the new era of globalisation, characterised by a strict IPR regime, a fast moving technology frontier and a move towards international harmonisation of quality standards, firms will have to explore the growing international market for generic drugs, the United States market in particular. Entry into this highly competitive market calls for stringent quality requirements. Indeed with the threat of ICH, not only US but the entire global market may be subjected to stricter quality norms. In this new era, the Indian manufacturers have to pay intensive attention to the concept of drug quality, which was hitherto largely ignored and adopt the following operational and organisational changes: • Quality control must be much more rigorous with stricter parameters and sophisticated instrumentation. • For formulations, the quality of active pharmaceutical ingredients (API or bulk) becomes all important. • High quality standards as per the multidimensional definition given above demand up-gradation of production and quality control technology. • The environmental dimensions of quality necessitate increased attention towards effluent treatment and proper waste management using modern methods and equipment. • Detailed documentation is becoming an important facet of production and quality control. • Finally, quality has added a new dimension to their R&D thrust. Firms are now trying to develop new improved analytical methods for quality specification and control. Some Indian firms have already succeeded in developing superior methods, which have been incorporated in the global quality standards like USP and European Pharmacopoeia (EP). In a sense, Indian players have thus contributed to outward shifts in the global frontiers of drug quality. Most of these elements of higher drug quality entail increased automation of the production process. In many cases, it requires complete overhauling of the plant set-

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up to install sophisticated (often imported) machinery and equipment for production and quality control. From “Business driven R&D” to “R&D driven Business” Technological capability of the Indian pharmaceutical industry can be classified into three broad groups: • Process development capabilities (bulk drug) • infringing and non-infringing • Product development capabilities (formulations) • conventional dosage forms (CDF), novel drug delivery systems (NDDS) of first and second generations (NDDS1, NDDS2 respectively) and analytical methods for quality • New drug discovery research (NDDR)

4.15 A possible solution to the product patent issue The most practicable solution to the problem which at the same time allows for TRIPs compliance would be granting of dual licenses. This would mean that the patent would be partly product patent and after a reasonable time being given to the inventor to make a reasonably large profit it would be converted to a process patent whereby the patented drug can be manufactured by competing manufacturers using an alternative process. This would solve the problem of excessive hike in prices and would render the drugs more accessible to the millions suffering. Collaboration with the MNCs on various fronts such as research and development, manufacturing and marketing will help Indian Pharmaceutical companies make profitable breakthroughs. As far as India’s pharmaceutical industry is concerned, various options are possible in the WTO regime. But ultimately, the path currently is followed by international standards for patent protection moves inevitably toward a clash between public health and intellectual property. Stringent intellectual property protection for pharmaceuticals would only retard public health initiatives in the coming years. Given the rapid evolution of the AIDS crisis throughout the world, with more than 35 million cases alone in India, a twenty year term of market exclusivity for new treatments is not reasonable if we expect to make real progress in containing the disease. It might well be appropriate for a governing body to clearly define a list of essential medicines, such as antiretroviral (ARV) agents, that would be subject to somewhat more relaxed patent protection compared to other drugs.

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5.0 MERGERS AND ACQUISITIONS (M & A) 5.1 Historical Background A merger or acquisition happens when two or more companies join together, often to share costs, increase efficiency or gain market power. Mergers and acquisitions, often referred to as M&A’s, is also a tool for expanding ones business or get around different laws or regulations such as tax laws or monopoly regulations. It is often thought of as a rather new phenomenon, the big consolidations of huge companies creating world leading multinational corporations. Nevertheless, it is not a new phenomenon. The first mergers started in the later half of the 19th century, sometimes as a method to expand market share almost into having a monopolistic market power. This has been known as the first wave of takeovers in the United States, but also as the start of mergers around the world. It is not definitely known why these mergers come in wave patterns and it is common that the mergers occur within different industry clusters. There are various factors that influence different industries through varying periods in time. The first wave that occurred in the United States from 1890 to 1905 was, a merger for monopoly. The common merger at that time was within the same industry between several producers, a so called horizontal consolidation which created large corporate giants, and an almost monopolistic market, such as General Electric, Eastman Kodak, and DuPont. The second wave came as a build-up phase after World War I in the 1920s. It was not near as big of an impact as the first wave, but it helped companies to merge and create strong corporations after the war and earlier market crash in the early 1900s. After World War II, the third wave of mergers came in the 1960s and was all about increasing market share by growth. At this time the M&A phenomenon also entered the U.K. in small proportion and started a trend that later would explode in the U.K. and rest of Europe in the late 1980s and early 1990s. It has been spoken of a fourth and a fifth wave as well. Many U.S. companies engaged in simultaneous expansions and downsizing of their businesses in the 1980’s. Focus lied towards expanding in areas where the firm had greater competitive advantage and downsizing in areas where they had not. Contrast with earlier waves was that the market experienced an active market in corporate assets. The fifth wave came in the 1990’s and is said to be the mother of all waves when it comes to the financial size of the mergers. The value of M&A’s was almost five times larger than the previous peak in 1989. A plausible explanation for the last wave is the introduction if new technologies like the internet, cable television and satellite communication. The first large M&A according to deal value that took place in the pharmaceutical industry was the consolidation in July 1989 when Philadelphia-based SmithKline Beckman was acquired by British Beecham Group to form SmithKline Beecham. This was a merger with a total deal value of $8.9 billion that set a trend for future massive mergers in the industry. It was also a huge transatlantic merger which combined the two world-leading pharmaceutical powers; United States and Europe, to unite in the search for generic drugs that could help us fight the diseases around the world. After the initial merger between the two large companies a row of mergers followed during the 90s and continued into the 21st century. Many renowned corporations in today’s society has been formed in the last 15 years and has become a multi billion dollar industry with giant corporations such as Pfizer, AstraZeneca and Novartis, all created through enormous mergers with the aim to lead research and development in every field of the pharmaceutical industry into the future. Page | 130

Figure 29: The Three Waves Cumulative M&A Spend

5.2 Mega-Deals Back on Pharma M&A Horizon From the circumstantial evidence of mediocre returns to the investment required to finance a major deal, it is clear that mergers and acquisitions should not be undertaken lightly. And yet, is there any doubt, in current market conditions with the huge pressure on the industry to match historic performance, that we will see yet another round of consolidation and a fourth wave of pharma M&A? Merger statistics for the first half of 2002 show that the healthcare industry is at the forefront of the current M&A frenzy. It dominates other industries in both the size and pace of deal activity with dollar transactions of $72 billion, three times higher than any other sector. However, a closer look at the data shows that while M&A activity continues unabated, the majority of these deals are almost insignificant when compared to the mega-mergers of the past M&A waves these deals represent millions rather than billions of dollars. The third wave, between 1998 and 2000, produced three largescale, high-dollar mergers: Pfizer/Warner-Lambert, GlaxoWellcome/SmithKline Beecham, and Pharmacia & Upjohn/Monsanto with big deal activity falling sharply at the end of 2000. Despite an active rumor mill, the majority of recent deals focused on portfolio rationalization and strategic repositioning rather than megamerger. Then came the announcement mid-2002 of the Pfizer/Pharmacia merger and the willthey/won’t-they rumors of a tie-up between GlaxoSmithKline and the beleaguered Bristol-Myers Squibb. Speculation that mega-deals are back on the pharmaceutical M&A horizon is rife. Table 31: Big Pharma M & As

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5.3 Winners and Losers in Pharmaceutical M&A So are the mega-mergers of the 1990s back again for another round? The answer is almost certainly yes, because, despite the potential pitfalls and expense, no CEO can afford to be left out of the market share race. In an industry characterized by fragmentation, the Pfizer/Pharmacia deal will give the new entity an unprecedented pro forma market share of 11.9%. This level of consolidation gives it a position almost 5% ahead of its closest competitor, GlaxoSmithKline. At this rate, within the next two to three years, the Top Five could become more powerful than the existing Top Ten. Figure 30: 2001 Global Market Share

5.4 Surviving the Scramble While we can only speculate what the new landscape will look like as evolving market pressures begin to bite and the short term rush to merge gives way to longer term acquisition strategies, two things seem certain mergers and acquisitions will continue and these transactions will never be straightforward. To realize the strategic benefits and shareholder value these mergers set out to achieve, we focus on three strategies to endure the impending scramble for survival. 5.5 Facts on the Three Cases of Megamergers There are numerous pharmaceutical companies in the world, and many of them have become large corporations through mergers or acquisitions. The companies have often merged or acquired other firms more than once, and thanks to these consolidations they have increased in size, increased their portfolios, increased their technological advancement, and become the great corporations of today. This following text handles three different major M&A’s within the pharmaceutical industry. These are some of the biggest companies in the industry. They were all started for different reasons and in different periods over time and they all operate all over the world. In the following text we discuss the three M&A’s chosen; who the original companies were, who acquired whom or if they merged, and why the consolidations occurred.

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5.5.1 Pfizer Pfizer is the largest pharmaceutical corporation today, and has become that just because of the many M&A’s through the years, especially in the last decade. Pfizer was founded by Charles Pfizer in 1849 in Williamsburg, USA, withholding only one single building containing research, office, factory and warehouse. It was during the Civil war fought in the late 1870s, and through World War II that Pfizer grew to become a well known company throughout the USA. In the early 50s, Pfizer expanded to South America and Europe, and a couple of years later partnered with Japanese Taito to reach the Far East, and partnered with a couple of more smaller companies to reach success around the world. It was not until the 21st century that Pfizer decided to grow substantially by merging or acquiring already large corporations. Figure 31: Mergers and Acquisitions of Pfizer

In June 2000 Pfizer merged Warner-Lambert to form one of the largest growing corporations in the world. Warner-Lambert’s history goes back to the middle of the 19th century when William R. Warner starts up his drug store in Philadelphia, and invented the early form of tablet-coating to make pills easier to consume. At the same time, John Wheat Lambert opened up his store in St. Louis selling antiseptic drugs. The two companies merged in 1955 and formed Warner-Lambert Pharmaceutical Company. Warner-Lambert came to grow through several acquisitions in the 60s and 70s, and was established all over USA with a larger product portfolio and large manufacturing plants. After the largest merger in American history with a deal value of $88.8 billions, Pfizer and Warner-Lambert became the world’s fastest growing major pharmaceutical company under the name Pfizer. Through constant concentration on research and development, and through building new high-tech manufacturing plants to further improve their production and canalizing their drugs out through the world, they have the largest market share in the world.

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On April 16, 2003, Pfizer purchased Pharmacia for an estimated $60 billion, forging one of the world's fastest-growing and most valuable companies. With a research and development budget of $7.1 billion in 2003, the new Pfizer is now the world's leading research-based pharmaceutical company.

"Today we go forward as a single company, providing more products to help more patients than any other pharmaceutical company has ever done before," said Pfizer Chairman and Chief Executive Officer Hank McKinnell. "On any given day, we estimate that nearly 40 million people around the world are treated with a Pfizer medicine. Our new company is the global leader in discovering, developing and delivering innovative medicines and health care solutions essential to improving global public health and addressing unmet medical needs." 5.5.2 Bristol-Myers Squibb Bristol-Myers was founded in the late 19th century by William Bristol and John Myers in Clinton, New York. The development of simpler products, among them the first disinfectant toothpaste, brought Bristol-Myers into the international market just after 15 years. The company grew through smaller acquisitions and would come to hold a broad portfolio of medicines. Squibb was founded a few decades earlier than Page | 134

Bristol-Myers on the east coast of USA. The pharmaceutical research started of in the early 1900s and by the time of 1944, Squibb had opened the largest penicillin production plant in the world and Squibb started to develop its business to South America and Europe, and grew further. In 1989, Bristol-Myers acquired Squibb in a $12 billion deal and created one of the leading pharmaceutical corporations in the world and what was then the second-largest pharmaceutical enterprise. Bristol-Myers Squibb accelerated their research and developed the second HIV-treating medicine by 1991 and launched one of the world’s most widely used cancer treatments. DuPont was founded over two centuries ago and started in the 1950s to develop their remedies for people that had smaller complaints. In 1982, after an acquisition, DuPont Pharmaceuticals was formed and would eight years later form a joint venture with Merck & Co which would lead to a developing business for DuPont. The 1st of October 2001, Bristol-Myers Squibb acquired the pharmaceutical division of DuPont and formed Bristol-Myers Squibb Company which is one of the world’s leading research and development pharmaceutical companies in the world with an immense position in HIV/AIDS and cancer treatment. 5.5.3 GlaxoSmithKline The Glaxo-SmithKline merger is the most valuable pharmaceutical merger through the eventful years in the industry 1989-2003. The single merger deal value between Glaxo and SmithKline was worth over $172 billions and tops every other merger with over twice the value of the others. Glaxo's history goes back 100 years and starts off by producing dried milk in New Zealand and exporting it to London, and later on starts up its business in London. In the 60s, Glaxo discovers skin disease treatments and asthma medicines. Glaxo acquires Meyer Laboratories Inc. and find a way into the American market. A few years later, Glaxo would develop and launch one of the world’s top-selling medicines. The medicine would be successful for the future of Glaxo, and in 1995 Glaxo merges with Burroughs Wellcome. They are now able to improve research and widen their portfolio including several important medicines that helps treating epilepsy, blood pressure and AIDS. Glaxo Wellcome is formed, and with a big portfolio and leading research in respiratory treatment they become an increasingly important and powerful corporation in the pharmaceutical industry. SmithKline’s history goes back a long time and is formed through several mergers during the years, and especially through Beecham Group’s acquisition of SmithKline Beckman in 1989. Up until the merger between the two big companies, Beecham had their research and top medicines in the allergy field. Through the merger a portfolio containing allergy medicines, skin care treatments and different important vaccines. After the merger in 1989 the research produced medicines that are still fundaments for today’s research and was, through more minor acquisitions, in 1994 the third largest over-the-counter medicines company in the world. In January 2001 Glaxo Wellcome and SmithKline Beecham fused into GlaxoSmithKline and is today one of the world’s leading research-based pharmaceutical and health oriented companies. 5.6 Recent M&A A review of the recent acquisitions and mergers indicates acceleration of the following trends:

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Table 32: Recent Mergers and Acquisitions

Company Pfizer Roche Merck Bayer J&J AstraZeneca Schering Plough Takeda Sankyo Teva Novartis Mylan Nycomed UCB Novartis Daiichi Sankyo Abbott GSK Shire Sanofi Aventis Barr Reckitt Benckiser Lilly Dainippon Watson Watson GSK King Toyama Solvay Richter Gedeon Shionogi J&J

Target company Wyeth Genentech Schering Plough Schering Pfizer OTC MedImmune Organon Millennium Daiichi Ivax Eon Merck KGA generic Atlanta Schwartz Hexal Ranbaxy Kos Steifel New River Pharma Zantiva Pliva Adams respiratory Icos Sumitomo Andrx Arrow Reliant Pharma Alpharma Fujifilm, Taisho Fournier Polypharma Sciele Cougar

$ billion 68 47 41 19.7 16.6 15.6 14.5 8.8 7.7 7.4 6.8 6.7 6 5.8 5.3 4.0 3.7 3.6 2.6 2.6 2.5 2.3 2.3 2.1 1.9 1.75 1.65 1.6 1.4 1.4 1.3 1.1 1.0

Consolidation in medical device, generic and consumer health segment of the healthcare industry and consolidation in the European and Japanese pharmaceutical industry. FDA new drug approvals in 2008 were 21 in comparison to 18 in 2007. With low R&D productivity and patent expiry of several blockbuster drugs, big pharmaceutical companies were diversifying into medical devices (J&J, Roche), generics (J&J, Novartis, Sanofi Aventis, and Daiichi Sankyo) and diagnosis (Roche). Biotechnology companies were acquired for monoclonal antibodies, RNAi and stem cells technology platform and R&D pipeline of oncology projects. Genentech rejected a $44 billion offer from its majority shareholder Roche for the remaining shares in 2008 but Roche has not given up and offered only $47 billion due to uncertain market conditions in early 2009. Pfizer bid of $68 billion for Wyeth and Page | 136

Merck 41 billion bid for Schering Plough show the push of traditional pharma into biologics. These bids have revived the M&A market. Companies like Amgen, BMS and Lilly need to act fast to grow, to acquire, merge or become a target. Mergers and acquisitions were successful if driven by a blockbuster marketed products like Lipitor (Pfizer- Werner Lambert), Niaspan (Abbott-Kos) and Cialis (Lilly-ICOS). New product derived mergers based on potential blockbuster marketed cancer drugs like Erbitux (Lilly-ImClone), Velcade (Takeda-Millenium) and Aloxi, Salagen; Hexalen (Eisai-MGI Pharma) will be successful. Roche potential takeover of Genentech will be a success. Pfizer takeover of Wyeth and Merck of Schering Plough will not resolve the low productivity of combined R&D to produce blockbuster drugs to replace Lipitor, Zocor and Fosamax. Analysts have termed it more a cost cutting effort and a shock absorber to patent expiry of Lipitor in 2011 as merger will dilute the affect of patent expiry. Wyeth only brings the best selling vaccine Prevnar and marketing rights to the best selling biotechnology (biologic) Enbrel to the combined company and has a week R&D pipeline and facing patent expiry of its blockbuster brands like Pfizer. J&J is one of the most successful acquiring company and with a Warren Buffett like approach of leaving the company management in place and benefiting from innovation. Its acquisition of Centocor and monoclonal antibody provided it with Remicade, the second top selling biologics and best selling monoclonal antibody in 2008. If a company was acquired for its R&D pipeline and development projects or platform technology, in majority of cases, the acquiring company failed to derive full benefits and most of the projects were later discontinued or terminated. Diversified companies like Roche, J&J, Abbott and Novartis with devices, generics and diagnostic performed better as compared to pure pharmaceutical R&D driven company in 2008. As biologic drugs move into multibillion dollar annual sales, are priced higher with respect to synthetic products and patent expiry had little effect on sales, and biosimilar or follow on biologic, unlike generics, need more time to gain market share. Pharmaceutical companies’ outright acquisition of biotechnology companies and licensing of technology/late stage projects in development has increased significantly despite market downturn and significant loss of market value of many biotechnology companies. This was evident by Merck acquiring Serono, Astra Zeneca absorbing MedImmune, Takeda taking over Millenium and Roche making a failed offer of 44 billion for the remaining shares of Genentech. There was a strong emphasis on biologics in R&D pipeline of big pharma companies and partnership and deals with biotechnology companies. Merck announced its entry into biosimilar biologics and the entry of 6 biosimilar erythropoietin in Europe and black box warnings and restrictions in dosage and clinical use resulted in loss of sales of all blockbuster EPO brands. The market and sales data in 2008 provides once again strong support for the R&D paradigm shift to biologic and within biologic towards human monoclonal antibodies, vaccines, erythropoietin, insulin’s and interferon. Major M & As in 2009 During the first half of 2009 we have seen the continuation of a trend toward consolidation in the biopharmaceutical industry with a number of significant mergers Page | 137

and acquisitions involving various combinations of acquirer type and target players. Among the highest-priced acquisitions, five involve big pharma and highlight their need to boost their pipelines and/or commercial portfolios. Big






Roche’s $46.8 billion acquisition of Genentech represents the former’s desire to gain access to Genentech’s revenues and its pipeline of oncology biologics. Over the past decade Roche had acquired a 56% stake in Genentech, and the companies worked closely and harmoniously, with the Swiss pharma giant receiving a lot of credit around the industry for leaving— at least for the most part—the princess of biotech alone to develop its oncology treatments. In July 2008, however, Roche made an offer of $89 per share to acquire the remaining 44% of Genentech’s outstanding shares. The deal eventually closed in March 2009 for $95 per share. The main motivation behind the acquisition for Roche was access to Genentech’s pipeline of marketed biologic agents for the treatment of cancer, including multiblockbusters Avastin, Herceptin, and Rituxan. In terms of merger integration, we expect to see a shift in R&D, with Genentech focusing on earlier-stage research and taking programs up to Phase II. Roche with its deeper pockets and longer experience will likely take over once a program is ready for Phase III testing and run late-stage trials. Big







Johnson & Johnson’s (J&J) $893.7 million purchase of Cougar Biotechnology was for access to a single drug: abiraterone acetate, a Phase III prostate cancer treatment. In May J&J announced that it was willing to pay $43 per share in cash, representing a 16% premium on the previous day’s close. Abiraterone, also known as CB7630, is an oral treatment and has shown impressive efficacy and safety results in four Phase II studies. Should the strong data on PSA responses and tumor shrinkage translate into overall and progression-free survival (PFS) advantages in the two pivotal Phase III trials, then J&J will benefit a lot more than the $893.7 million it paid. Abiraterone could become a successful drug commercially with the potential to reach multiblockbuster status given its safety profile, oral administration, and the large market it addresses. This acquisition, however, is not without risk for J&J: All the data we have seen thus far from the abiraterone trials are from uncontrolled, open-label, single-arm studies. Additionally, efficacy results albeit impressive will have to surpass the hurdle of translating into a survival and PFS benefit. In another example of a big pharma acquiring a smaller biotech, GlaxoSmithKline acquired privately held Stiefel Labs for $2.9 billion this April. Stiefel is a dermatology specialist selling both prescription and OTC products including medications for acne. It grossed about $900 million in sales during 2008. The main impetus behind GSK’s acquisition of Stiefel was its desire to increase its presence in the dermatology space, which resulted in $550 million in sales last year.

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This acquisition is viewed as being completely on the other end of the spectrum from the J&J/Cougar acquisition in many ways. There is limited clinical and commercial risk associated with the Stiefel takeover, since its products are already on the market. Big







This year has seen two such mergers: Merck & Co. with Schering-Plough and Pfizer with Wyeth. 2009 opened with the $68 billion Pfizer/Wyeth marriage, combining the most powerful pharma sales and marketing machine with one of the most highly regarded and most “biotechy” of the U.S. large-cap pharmas. The result is a company with a combined $71 billion in sales. The $68 billion price tag is nothing to sneeze at, of course, but we remind investors that in 2000, Pfizer paid $89 billion for Warner Lambert. The impetus behind Pfizer’s desire to acquire Wyeth has a lot to do with the impending Lipitor patent expiration in 2011. The drug has brought in about a quarter of the company’s revenues every year. In terms of cost savings, the companies believe they’ll save approximately $4 billion annually, which partially comes through a 15% reduction of their combined workforce. Pfizer is undoubtedly known for its ability to take products it has acquired or inlicensed and market them extremely effectively. On the other hand, Wyeth has its own blockbusters including Enbrel for the treatment of rheumatoid arthritis, which is codeveloped with Amgen, and Prevnar, a pediatric vaccine. Plus it has one of the most promising pipelines among U.S. big pharma companies, so the marriage of the two makes a lot of sense, at least at the high level. The next big pharma merger came in early March when Merck acquired ScheringPlough for $41 billion. Merck is losing patent protection for Cozaar, a hypertension drug, as well as Singulair, which treats allergies and asthma. Schering-Plough, on the other hand, has relatively few products that are close to patent expiration. Finally, Schering-Plough has a strong ex-U.S. presence, generating about 70% of its revenue outside the U.S. The synergies and cost savings could come from the streamlining and re-focusing of the R&D, sales, and marketing organizations. All told, these acquisitions total $109 billion. Additionally, having come in such close succession, they mark a heightened level of interest on big pharma’s part in the biotech space. The consequences of such major consolidations will not be evident for a while, and questions remain as to whether we’ll see the bigger biotechs implement a similar acquisition strategy. These large biotechnology firms continue to face the need to replenish their pipelines given the demand for continued revenue and bottom-line growth and the ever increasing threat from biosimilars.

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5.7 Steps involved in Mergers and Acquisitions (M&A): A company starts with a tender offer to purchase another company. Once the tender offer has been made, the target company can resort to one of the options: Accept the Terms of the Offer and go ahead with the deal; Attempt to Negotiate for a high price; Execute a Poison Pill or Some Other Hostile Takeover Defense – A poison pill scheme can be triggered by a target company when a hostile suitor acquires a predetermined percentage of company stock. To execute its defense, the target company grants all shareholders – except the acquiring company – options to buy additional stock at a huge discount. This dilutes the acquiring company’s share and intercepts its control of the company. Mergers and acquisitions can face scrutiny from regulatory bodies. For example, when the two biggest telecom companies in the US, AT&T and Sprint, wanted to merge, the deal had to get the approval of the Federal Communications Commission (FCC). The FCC would probably regard a merger of the two giants as the creation of a monopoly or, at the very least, a threat to competition in the industry. Finally, once the target company agrees to the tender offer and regulatory requirements are completed, the deal will be executed. An M&A deal can be executed by means of a cash transaction, stock-for-stock transaction or a combination of both. The completion of a merger does not necessarily offer advantages to the resulting organisation. After merging, the companies hope to benefit from the following: Staff reductions, economies of scale, acquiring new technology, improved market reach and industry visibility. But, many mergers or acquisitions sometimes do just the opposite and result in a net loss of value due to problems. Correcting problems caused by incompatibility – whether of technology, equipment, or corporate culture – diverts resources away from new investment, and these problems may be exacerbated by inadequate research or by concealment of losses or liabilities by one of the partners. Overlapping subsidiaries or redundant staff may be allowed to continue, creating inefficiency, and conversely, the new management may cut too many operations or personnel, losing expertise and affecting employee morale. These problems are similar to those encountered during takeovers. Regardless of their category or structure, all mergers and acquisitions have one common goal of creating synergy that makes the value of the combined companies greater than the sum of the two parts. The success of a merger or acquisition depends on whether this synergy is achieved. In other words, the success of a merger is measured by whether the value of the buyer is enhanced by the action. 5.8 Reasons for mergers and acquisitions There are many driving forces for a merger. They can have pure financial motives, market share motives or as a mean to diversify ones portfolio. Many common reasons for a typical merger are not necessarily the ones most significant for the M&A’s in the pharmaceutical industry. The biggest expenditures within the pharmaceutical industry are the investments in research and development and the production costs of making the medicines. There are huge amounts of profits that go back to R&D. With many corporations trying to develop medicines for the same kind of diseases, it sometimes makes more sense to merge to gather your forces with another company to maximize the efficiency to develop new drugs, benefit from economies of scale, utilize each Page | 140

others manufacturing plants and use each others channels for distribution and finally to expand into new geographic markets and to lower costs by reducing excess capacities. Loss of Patent Protection Big Pharma is expected to experience the loss of patent protection on a substantial number of drugs between 2010 and 2013. One way that companies might avoid a drop-off in revenue in the coming years is to use their cash and strong balance sheets to acquire smaller/weaker rivals. Acquisitions of both small and midsize biotechs and weaker pharma rivals are expected. While acquisitions will continue to be a part of pharma’s strategy, they will likely look to other sources of innovation, too. For example, pharma is showing renewed interest in collaborating with universities for inspiration in basic research. Consequently, licensing activity between universities and pharma is likely to increase. Economies of Scale There is a growing consensus that horizontal mergers between equals often do not result in efficiencies and savings in the pharma sector. While activities such as commercialization and distribution are often scalable, R&D efficiency often suffers during a horizontal merger of two large pharma companies. There are several examples of horizontal M&A activities that have not resulted in more efficient organizations. Pfizer’s acquisition of Warner Lambert and the Glaxo Wellcome and SmithKline Beecham’s merger, both in 2000, are examples of reduced operational efficiency resulting from integration of equals. Two other types of acquisitions might benefit pharmaceutical companies in the coming years. First, big pharma realizes that more efficiency can often be extracted from multiple, smaller acquisitions instead of a single mega-acquisition. As a result, big pharma will increasingly look to acquire small to midsize biotech companies with strong R&D pipelines. Second, pharma might benefit from acquisitions of generics manufacturers, which serve the large-volume, low-margin market. Acquisitions of generics would provide a cash cow and also allow pharma companies to capitalize on their strengths in distribution and marketing. However, this type of deal is likely to draw regulatory scrutiny. Financing The market valuations of biotech and pharma companies are at historic lows, indicating that big pharma might be able to acquire companies at deep discounts. At the same time, pharma companies have a strong balance sheets and solid revenue streams, despite the financial turmoil, providing the wherewithal to pluck deals based on lower market caps without highly leveraging the deals. Both public and private equity markets have experienced a recent decline in access to capital, as a result of the credit crisis. In 2007, private equity activity was extremely strong because of access to inexpensive financing. Private equity firms were able to buy small- to medium-sized biotechs and then quickly sell them to big pharma for a profit. However, since early 2008, the private equity markets have dried up. Instead, big pharma has begun to buy small- and mid-size biotech firms directly. Private equity investors also started holding onto their investments longer. Page | 141

There was a substantial amount of activity on the public equity markets in 2007, when a total of 13 med-tech company IPOs raised around $1.1 billion. IPO activity declined precipitously in the first half of 2008, with only two medtech companies, CardioNet and MAKO Surgical, going public. Now, investors in small- to mid-size, private medtech companies are looking at being acquired, instead of an IPO, as their exit strategy. Recently, there have been several reports of negotiations between biotechs and big pharma, but few deals have closed. For example, Roche’s play for Genentech has not been completed despite months of negotiations. Biotech firms with strong pipelines, such as Genentech, often have the upper hand in negotiations, so deal valuations remain high. As a result, big pharma is often reluctant to commit to the asking price. However, recent data indicates that the pendulum has shifted towards big pharma having the upper hand in negotiations. Currency trends The acquisition of US-based pharmaceutical firms by foreign competitors allows the foreign firm to establish a presence in the US, particularly a sales presence and a relationship with the FDA. When the dollar was weak in early 2008, there were many examples of foreign pharma companies acquiring US rivals. For example, Takeda Pharmaceuticals acquired Millenium Pharmaceuticals for $8.8 billion in cash, and AstraZeneca bought MedImmune for $15.6 billion. Currency trends could continue to influence acquisition activity in the pharma sector. Since September, the US dollar has risen roughly 15 percent in value relative to the euro. On the other hand, the Japanese yen has strengthened substantially against both the euro and the dollar, making foreign acquisitions more attractive to Japanese companies. If the dollar loses value relative to other currencies in coming months, US companies will become more attractive for acquisition. Conclusion Big pharma will continue to look for acquisition opportunities to increase their product pipelines and utilize their core strengths in product development and distribution. At the same time, companies will become more selective in the acquisitions they pursue, due to the current economic uncertainty. Thorough due diligence, including assessments of IP and technology, are necessary prior to any acquisition to ensure that the acquired organization is a good fit. By understanding the strengths and weaknesses of the acquisition target, big pharma will be able to maximize the market potential for the acquired products/platform technologies and anticipate any challenges that are presented after the acquisition.

5.9 Mergers, Acquisitions and Alliances: Why they can Fail The chances of success are hindered if the corporate cultures of the companies are poles apart. When a company is acquired, it is typically based on product or market synergies, but cultural differences are often ignored. For example, employees at a target company might be accustomed to easy access to top management, flexible work schedules and a relaxed dress code. These aspects of a working environment may not seem significant, but if the new management removes them, the result can be resentment and shrinking productivity. McKinsey, a global consultancy, has found from its research study that most mergers or acquisitions fail, because the companies often focus too intently on cutting costs following mergers, while revenues and profits suffer. Merging companies focus on integration and cost-cutting so much, that they Page | 142

neglect day-to-day business, thereby prompting nervous customers to flee. This loss in revenue momentum is one reason for its failure. 78% of mergers and acquisitions fall apart within three years of their inception. About 70% of alliances fail outright, fall captive to shifting priorities, or achieve only initial goals, and 55% fall apart within three years of their creation. Internal alignment and understanding are important for mergers, acquisitions and alliances. Having the capability to build and maintain internal alignment is defined as having an effective implementation process for identifying key decisions and issues related to a partnership, knowing who the relevant stakeholders are, and consulting with stakeholders to keep the organisation informed and involved throughout the lifespan of a partnership. Lack of internal alignment and understanding leads to: • Poor or uninformed decisions about whether to enter into an alliance • Significant risk of sending confusing messages to, or acting inconsistently toward, its partners, misleading or confusing them, and jeopardising trust between them • Internal bickering, non-delivery, and strain on internal resources as people are left unclear about priorities and focus. 5.10 Indian Pharmaceutical: Ripe For Consolidation The Indian pharmaceutical industry is characterised by the twin benefit of strong domestic consumption growth on the one hand and robust export opportunities on the other. At the same time, the intense competition in a highly fragmented market is posing a great challenge too. The stage is set for the next phase of growth accompanied by consolidation. This stage will see traction owing to the global meltdown of equity markets that has brought the valuations at very attractive levels. With the increasing need of capital for sustaining the growth momentum or even sustaining in the business due to the highly competitive environment and limitations on the ability to introduce new drugs due to the new patent regime, a number of Indian pharmaceutical companies will find it difficult to pursue the growth path on their own. Such companies will be ideal candidates to join hands with strong multinational companies. The acquisition of India’s largest drug-maker Ranbaxy Laboratories by Daiichi Sankyo Company Limited, one of the largest pharmaceuticals companies of Japan last year is an apt example in this context. The foreign pharma companies already operating in the Indian market are also trying to increase their stakes in the domestic subsidiaries, which indicates the growing importance of this market for them. In the last week of March, Swiss firm Novartis International AG and Pittsburgh-headquartered Mylan Inc announced plans to significantly hike equity stakes in their Indian subsidiaries. The leading multinational pharmaceutical companies are increasing their focus on emerging markets such as India and China in their growth plans, as pointed out by a global survey of top 15 pharmaceutical companies conducted by Ernst & Young, one of the largest professional services firms. An Active Sector For M&A And Private Equity Deals Pharmaceutical, Healthcare & Biotechnology was one of the busiest sectors on the deal street of India in 2008. It was second in terms of total value with $5.57 billion, marginally below the Telecommunication sector which had total transactions worth Page | 143

$5.78 billion, according to a report of consulting firm Grant Thornton. In terms of volume, the Pharma sector had 57 deals, second to 102 deals in Information Technology & IT-enabled Services sector. The $4.60 billion acquisition of Ranbaxy Laboratory, India’s largest drug-maker, by Japanese firm Daiichi Sankyo Co., Ltd was on the top of the table of India’s largest deals in 2008. Out of the total 57 M&A deals in the sector, 17 deals were domestic. Table 33: M & A’s by Indian companies

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5.11 Impact of Mergers and Acquisitions on Performance Having analysed the nature and structure of mergers and acquisitions in this industry, the next question arises would be to what extent the consolidation strategies helped them to improve their position. This is done in a comparative framework of the performance of merging and non-merging firms on the one hand and pre and post merger performance on the other. Mergers and acquisitions are expected to change the performance of merging firms in two ways. One is through an increase in the scale factor, which in turn will reduce the total cost of production of the merging firms, which will result in the better performance. It is also likely that mergers and acquisitions may give monopoly power to the merging firms in the market and this will give them powers to increase the ‘mark-up’ which again lead to high prices and ultimately to high profits. Sometimes mergers will reduce the performance of the merging firms if it acquires loss-making firms and are not able to derive the expected synergies. Also if the industry is less colluded, the combined market share of the merging firms could fall, which result in loss of market shares and low profitability. Merging vs. Non Merging Firms A merging firm arises only after making the first merger/ acquisition and until that it would be a non-merging firm. Four measures of profitability such as Gross Profit Margin (GPM), Net Profit Margin (NPM), Return on Capital Employed (ROCE) and Return on Net worth (RON) were studied. Interestingly all these ratios have shown that the merging firms are more profitable compared to the non-merging firms and this difference is statistically significant at one percent level and both type of firms are volatile as shown by the CV (Co-efficient of Variation). Likewise the R&D intensity of the merging firms are very high (2.3 and 1.35 respectively) compared to the other. The R&D intensity of the merging firms show high variability as compared to that of non-merging firms, which indicates that only a few merging firms are able to invest more on R&D. Besides Research and Development expenditure, another major determinant of sustaining market growth is the selling cost, mainly the marketing expenditure rather than advertisement expenditure. This is because the companies are approaching the prescribing doctors in the case of ethical drugs market rather than patients, which force them to spend on marketing through sales representatives. The average advertisement intensity for merging firms remained slightly higher than that of the nonmerging firms (1.29 and 1.07), which is not a statistically significant difference too. Albeit, the average value of the marketing intensity of the merging firms is only 3.7 and that of the non-merging firms are 4.34. Interestingly, the coefficient of variation for the merging firms is so low as compared to that of nonmerging firms, which shows that even large firms among the merging firms are not spending more on marketing. Mergers and acquisitions enabled them to share common marketing outlets, which reduced this expenditure considerably. Besides, these firms have also gone for many strategic marketing alliances, which could have helped them to derive marketing synergies along with this. Merging firms are also having high export and import intensity. The high import intensity may be due to their dependence on bulk drug import. The gains from the high export intensity may be offset by the high import intensity. Even though mergers and acquisitions are expected to increase the capacity utilization of the merging firms due to the expansionary reasons, capacity utilisation is lower than that of the nonmerging firms during the post merger period. The ratio for merging firms is 82.57 and for non-merging firms 87.58. However, since the mid-1990 the ratio for the merging firms outweighs that of the other. Page | 145

Figure 32: Performance of Merging and Non-merging Firms

Thus from the above discussion it is clear that the performance of merging firms during the post-merger period was far better as compared to the non-merging firms in terms of most of the performance indicators (see Figure 32). Product Diversification through Consolidation Firms may opt for mergers in order to reduce the risk and uncertainty. If a firm is more diversified, then there is greater possibility of obtaining stable return. Any losses in one particular market can be offset by profit in some other market. Mergers enable firms to diversify their production by adding new product to more therapeutic categories and thereby not only reduce risks, but also expand their market size. The synergy effect of merger will enable the firms to either deepen or extent product structure. Table 34: Product Diversification of Merging Firms between 1990 and 2005

Source: Compiled from Monthly Index of Medical Specialities, Various Issues Page | 146

Similarly, the merger of Tamilnadu Dadha Pharmaceuticals with Sun Pharmaceuticals enabled Sun Pharmaceuticals to add oncology, biotechnology and anesthesiology to its diverse product portfolio. Further when Glaxo made the first domestic acquisition, by acquiring 100 percent equity stake in the Biddle Sawyer, Meghdoot Chemicals and Cryodon Chemical Works in 1997, these three firms had their brands accounting for around one percent of the formulation market. They had strength in anti-asthmatics, orthopaedical gynacology and nephrology products, which added to Glaxo’s product portfolio. Thus it becomes very clear that mergers and acquisitions enabled the merging firms to expand their product portfolio and thus reduce their risk as well as helped them to derive marketing synergies. 5.12 The challenge While growth via acquisitions is a sound idea in principle, there are challenges as well, which relate mainly to the stretched valuations of acquisition targets and the ability to turn them around within a reasonable period of time. The acquisitions of RPG Aventis (by Ranbaxy) and Alpharma (by Cadila) in France are clear examples of acquisitions proving to be a drain on the company’s profitability and return ratios for several years post acquisition. In several other cases acquisitions by Indian generic companies are small and have been primarily to expand geographical reach while at the same time, shifting production from the acquired units to their cost effective Indian plants. A few have been to develop a bouquet of products. Other than Wockhardt’s acquisition of CP Pharma and Esparma, it has taken at least three years for the other global acquisitions to see break-even. Most of the acquiring companies have to pay greater attention to post merger integration as this is a key for success of an acquisition and Indian companies have to wake up to this fact. Also, with the increasing spate of acquisitions, target valuations have substantially increased making it harder for Indian companies to fund the acquisition 5.12.1 Analysis of Wockhardt’s acquisition Wockhardt is a global, pharmaceutical and biotechnology company that has grown by leveraging two powerful trends in the world healthcare market - globalization and biotechnology. Acquisition Management The company has a strong track record in acquisition management, with three successful acquisitions in the European market and two in the domestic space. The acquisitions in Europe and the subsequent integration of their operations have strengthened Wockhardt’s position in the high-potential markets of UK and Germany, and have expanded the global reach of the organization. The growth drivers for Wockhardt’s European business include exports, new product launches, penetration in the European Union through mutual recognition, and strategic acquisitions. • Wockhardt UK Limited (Erstwhile CP pharmaceuticals) is amongst the 10 largest generics companies in UK and the second largest hospital generics supplier. • The Company has a comprehensive, FDA-approved manufacturing facility for injectables that plays a strategic role in driving the company’s growth through partnerships in contract manufacturing. • Wockhardt UK has built up a critical mass in the segments of Retail Generics, Hospital Generics, Private Label GSL / OTC Pharmaceuticals, Dental Care (denture cleaning tablets, powders and fixative creams). • The acquisition of Esparma GmbH in 2004, has given Wockhardt a strategic entry Page | 147

point into Germany, the largest generics market in Europe. • Esparma has a strong presence in the high-potential segments of urology, neurology and diabetology, assisted by a dedicated sales & marketing infrastructure. The key to Wockhardt’s successful acquisition management is the management’s ability to turnaround the acquired company in record time and thus create value out of the acquisition. The company believes in value buys that would have a tactical fit with its core competencies and key strategic objectives. The acquisitions are mainly driven by market access since Wockhardt has an extensive pipeline of generics and biogenerics and needs a strategic front-end for the same. The company has plans for further acquisitions in the developed markets of Europe and US to further consolidate and strengthen their positions in these geographies. 5.12.2 Implications of the merger of Ranbaxy and Daiichi Daiichi Sankyo Co. Ltd. signed an agreement to acquire 34.8% of Ranbaxy Laboratories Ltd. from its promoters. After the acquisition, Ranbaxy continued to operate as Daiichi Sankyo’s subsidiary but was managed independently. The main benefit for Daiichi Sankyo from the merger was Ranbaxy’s low-cost manufacturing infrastructure and supply chain strengths. Ranbaxy gained access to Daiichi Sankyo’s research and development expertise to advance its branded drugs business. Daiichi Sankyo’s strength in proprietary medicine complemented Ranbaxy’s leadership in the generics segment and both companies acquired a broader product base, therapeutic focus areas and well distributed risks. Ranbaxy is now functioning as a low-cost manufacturing base for Daiichi Sankyo. Ranbaxy, for itself, has gained a smoother access to and a strong foothold in the Japanese drug market. The immediate benefit for Ranbaxy was that the deal freed up its debt and imparted more flexibility to its growth plans. Most importantly, Ranbaxy’s addition is said to elevate Daiichi Sankyo’s position from 22 to 15 by market capitalization in the global pharmaceutical market. Synergies The key areas where Daiichi Sankyo and Ranbaxy are synergetic include their respective presence in the developed and emerging markets. While Ranbaxy’s strengths in the 21 emerging generic drug markets can allow Daiichi Sankyo to tap the potential of the generics business, Ranbaxy’s branded drug development initiatives for the developed markets will be significantly boosted through the relationship. To a large extent, Daiichi Sankyo will be able to reduce its reliance on only branded drugs and margin risks in mature markets and benefit from Ranbaxy’s strengths in generics to introduce generic versions of patent expired drugs, particularly in the Japanese market. Both Daiichi Sankyo and Ranbaxy possess significant competitive advantages, and have profound strength in striking lucrative alliances with other pharmaceutical companies. Despite these strengths, the companies have a set of pain points that can pose a hindrance to the merger being successful or the desired synergies being realized. With R&D perhaps playing the most important role in the success of these two players, it is imperative to explore the intellectual property portfolio and the gaps that exist in greater detail. Ranbaxy has a greater share of the entire set of patents filed by both companies in the period 1998-2007. While Daiichi Sankyo’s patenting activity has been rather mixed, Ranbaxy, on the other hand, has witnessed a steady uptrend in Page | 148

its patenting activity until 2005. In fact, during 2007, the company’s patenting activity plunged by almost 60% as against 2006. Post-acquisition Objectives In light of the above analysis, we see that Daiichi Sankyo’s focus is to develop new drugs to fill the gaps and take advantage of Ranbaxy’s strong areas. In a global pharmaceutical industry making a shift towards generics and emerging market opportunities, Daiichi Sankyo’s acquisition of Ranbaxy signals a move on the lines of its global counterparts Novartis and local competitors Astellas Pharma, Eesei and Takeda Pharmaceutical. Post acquisition challenges included:• Managing the different working and business cultures of the two organizations • Undertaking minimal and essential integration • Retaining the management independence of Ranbaxy without hampering synergies. Benefits to Ranbaxy and Daiichi from the merger • Daiichi Sankyo’s move to acquire Ranbaxy has enabled the company to gain the best of both worlds without investing heavily into the generic business. • Furthermore, Daiichi Sankyo’s portfolio has broadened to include steroids and other technologies such as sieving methods, and a host of therapeutic segments such as anti-asthmatics, anti-retroviral, and impotency and anti-malarial drugs. • Daiichi Sankyo now has access to Ranbaxy's entire range of 153 therapeutic drugs across 17 diverse therapeutic indications. • Through the deal, Ranbaxy has become part of a Japanese corporate framework, which is extremely reputed in the corporate world. As a generics player, Ranbaxy is very well placed in both India and abroad. • Given Ranbaxy’s intention to become the largest generics company in Japan, the acquisition provides the company with a strong platform to consolidate its Japanese generics business. From one of India's leading drug manufacturers, Ranbaxy can leverage the vast research and development resources of Daiichi Sankyo to become a strong force to contend with in the global pharmaceutical sector. A smooth entry into the Japanese market and access to widespread technologies including, plant, horticulture, veterinary treatment and cosmetic products are some things Ranbaxy can look forward as main benefits from the deal.

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6.0 OBSERVATIONS Major pharmaceutical companies face a paradox. The potential for medical breakthroughs has never been more exciting, yet the operating environment has never been more difficult. Cost-reduction programmes announced in the wake of mergers and acquisitions will address only some of the challenges facing the industry. Pharmaceutical companies need to find some new remedies and operating strategies to restore growth. Pharmaceuticals used to be a safe investment: shareholders could rely on steady earnings and a 30% to 40% premium to fair value. However, since 2000, the industry has consistently disappointed, losing around 40% of market capitalisation between the end of 2000 and the middle of 2002. Even though it has clawed back half of that fall since 2002, the sector has destroyed nearly $400 billion of value over the past four years. That poor performance is the result of a number of factors. Big pharmaceutical companies were lulled into complacency by their reliance on a handful of best-selling “blockbuster” drugs, with at least $1 billion in annual sales, whose patents are now expiring. Safety concerns have led to the worldwide withdrawal of several drugs, notably Merck's $2.5bn-a-year painkiller Vioxx, while assertive patients are more willing to take legal action against “big pharmaceuticals”. The reputation of the “ethical pharmaceutical industry” has suffered still further as a result of its own activities. It has raised prices to the maximum in the USA and Western Europe, used every legal means at its disposal to defend patents and been reluctant to provide cheaper medicines to developing countries. From a purely commercial standpoint, these may have been sensible actions. But, taken together, they have destroyed the public’s regard for pharmaceutical companies. The extent to which pharmaceutical companies bankroll doctors and hospitals by funding trials, research and conferences is another area where they are vulnerable to accusations of improper practices. And pharmaceutical companies are spending too heavily on marketing: around half of their marketing costs are accounted for by free samples handed out to doctors to persuade them and their patients to use new medicines and most of the remainder is spent on the salaries and commissions of medical sales representatives. Moreover, nearly every top-tier drugs company has resorted to acquisition to sustain its growth. This has created bloated companies carrying too much fat, whilst hiding a crisis of productivity in innovation. There is overwhelming antipathy to M&A among researchers and widespread fear among executives about the disruptive effect of consolidation on drug discovery. The biggest threat to the industry's profitability is a slump in output by research departments responsible for creating new medicines. In any pharmaceutical company, successful products can probably be traced to a small number of brilliant scientists and constant M&A activity muddies the water for these individuals. They lose control of projects and the ability to spot winners and champion them through the organisation and on to market. AstraZeneca, for example, now has 50% more drugs in the early stages of development as a result of reorganising Astra and Zeneca's research units. But that rise comes five years after the merger, which saw 6000 people move jobs. There's a productivity problem at the most basic level and the industry is not getting output consistent with the increased R&D spending it's providing. Yet, in theory, the industry’s long-term prospects seem attractive. Demand for drugs should grow steeply for several reasons: Page | 150

• Economic and demographic changes. Developing nations become richer as life expectancy rises and are able to increase spending on healthcare. In developed nations, the population is ageing, driving demand for drugs to treat the chronic diseases of old age, while the younger population is increasingly suffering from chronic “lifestyle” diseases such as hypertension. • There is a strong economic case for greater spending on medicines rather than on more expensive hospital treatments. • The evolution of medical understanding, including the mapping of human genome, has raised to prospect of important further advances in treatment through pharmacology. It is necessary for pharmaceutical companies to address the complex subject - how to provide broader access to their intellectual property. Keeping prices high in poor developing countries limits sales and inflict public relations backlash. The matter is thornier in middle-income countries, where pharmaceutical companies have more at stake. However, lower prices in these middle-income countries could be used as benchmarks by rich countries to negotiate better prices - that would put even more pressure on prices. On the other hand, sporadic pickings of relatively small royalties are less attractive than the tiered pricing since license a patent to rivals under pressure is not a sensible thing to do. In addition, governments can invoke their rights to “compulsory license” a medicine when their citizens are threatened by a public health crisis (such as an avian flu pandemic). And, it is not easy to drive a hard bargain with multiple governments while many international organisations are watching and giving friendly but unwanted advice. The principle of tiered pricing has already been established with HIV/Aids anti-retroviral. Therefore, this method of pricing to both developing and developed countries makes business sense. There is consensus within the pharmaceutical industry that small is beautiful: large size in research organisations is an impediment to good inter-disciplinary team effort, especially in discovery and the early stages of development. We also believe that research strategy for drug discovery and development matters just as much. Companies must re-assess their mix of biologic and small molecule approaches to known and novel targets. While small molecule or chemical drugs that target novel mechanisms are much less successful than those designed to work against known targets (6% success rate for novel targets compared with 19% for known), the difference in success rates for biologics is much smaller (21% success rate for novel targets compared with 27% for known). Companies must also re-assess their technology mix in specific disease areas like cancer. For example, broad-acting cancer therapies are less successful than targeted therapies (5% compared with 30%), and yet companies continue to invest almost half their budget in researching broad-acting therapies. Pharmaceutical companies need to take a hard look at detailed data on success rates before making investment decisions, and to manage their portfolio risk more effectively to take account of these figures. At the same time, companies need to re-evaluate their business strategies. Among the leading pharmaceutical companies, there is very little consensus about the best way to compete. For example, as understanding of human genetic variation influences the choice of drugs, Roche has chosen to focus on specialty medicines and a diagnostic business designed to put it at the forefront of “personalised medicine”. Novartis now operates the world’s largest generic business, after paying €6 billion to merge Hexel with its Sandoz subsidiary. Johnson & Johnson has placed its faith in decentralising its various businesses, diversifying into the fast growing market for medical devices Page | 151

as well as pharmaceuticals. Johnson & Johnson also achieved its target of cutting costs by $1 billion in 2004, while a fourth consecutive year of flat or falling profits prompted Merck to pledge deep cost reductions across the company, including $300 million of savings planned for 2005 and a further 5100 job cuts by end of 2004 on top of 4400 job cuts which had previously been announced. Yet the $6 billion cost reduction programme announced by Pfizer after combining with Pharmacia in 2003 indicates just how much fat remains in the sector.

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7.0 SUGGESTIONS The steps required to boost the competitiveness of the pharma industry are: 7.1 Extension of deduction of 150% of R&D expenses. This would encourage more and more companies to invest in R&D. The government has earmarked 150 crores for R&D. This is just not enough. It should be augmented to at least 2000 crores. 7.2 To rationalize Drug Price Control Order (DPCO). The objective of the price control was to ensure adequate availability of quality medicines at affordable prices. In this context, a liberalized price control regime becomes more important. 7.3 Income tax exemptions should be given on clinical trials and contract research done outside the company and abroad. This is because India is seen as emerging as a major center for outsourcing of clinical trials for the Pharmaceutical MNCs. 7.4 The problem of spurious drugs has to be tackled. Most of the cases relating to spurious drugs remain undecided for years. Hence there is a strong need for setting up separate courts for speedy trials of such offences. 7.5 India should exploit its know-how in herbal medicines. Since these medicines do not come under the purview of the TRIPS regime and the research in new chemical entities involves millions of dollars of investment, the Indian companies should engage in R&D in herbal medicine. The companies should try to exploit the Indian traditional knowledge in ayurveda and herbal cures and file as many patents for herbal medicine as they can. For this the government should set up R&D laboratories undertaking research exclusively in the area of herbal medicines and support the companies in their research and patent filing. 7.6 The government should encourage setting up of USFDA-compliant plants by providing tax holidays for a specified period; so that the Indian companies can exploit the opportunity arising out of patented drugs and take up marketing of generics in the developed countries like USA.

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8.0 CONCLUSION Big Pharma is heading "off a cliff" and into "a black hole," according to Wall Street. Analysts are already using such big scary metaphors to describe the challenges facing the drug industry in five years, when drug makers will face the worst series of patent expirations ever. Between 2010 and 2011, Big Pharma will lose 28% of their current sales, according to pharmaceutical analyst James Kelly of Goldman Sachs--who is calling this period "the patent black hole." Starting in 2008 and going through 2011, analysts predict annualized sales growth of only 2% for big drug makers. Analysts believe that the loss of blockbuster products like Pfizer's Lipitor for high cholesterol, the world's best-selling drug, and Eli Lilly's Zyprexa for schizophrenia, is shaping decision-making at big drug makers. After analyzing the industry from the global, Indian, and individual organizations’ perspective it remains impossible to predict its future due to several reasons such as the flurry of shape-shifting activities taking place at the global level, uncertainty about the various roles emerging markets will play in the near future, growing public concern about the ethicality of the practices of large pharmaceutical companies (usage of the term ‘blockbuster’ drugs, for instance), intentions of leaders of several developed nations (Barack Obama, the President of U.S. in particular) to bring down healthcare costs, and so on. Understanding the industry from a local as well as global viewpoint has revealed, among other things, this: India’s importance in the global drugs and pharmaceutical industry has grown substantially and continues to grow. Significant advances have taken place in the field of research and marketing in the past decade. The level of professionalism in the management of pharmaceutical companies has also risen. A number of Indian players have entered foreign nations, a large share of them doing so by marketing their drugs there directly. Indian companies have also purchased companies across the globe, from the United States to UK, Ireland, Germany, France, Belgium, Italy, Poland, Romania in Europe, to South Africa and to Japan and Singapore in Asia. Since 2000, there have been more than 60 foreign acquisitions by Indian companies. Dr. Reddy’s Labs acquisition of Betapharm of Germany for US$ 597 million stands fourth amongst the top ten acquisitions by Indian companies based on deal value. Such acquisitions have widened the companies’ markets and provided them access to knowledge and technology that would have otherwise taken years to get a hold of. Most important about the Indian chapter of the drugs and pharmaceutical industry is that it is not dependant on foreign aid and neither is it incapable of going beyond where it stands at present. What remains to be known is whether India will follow the path of the I.T. industry and become a outsourcer/low-cost hub or will it do something not preceded by any other industry by climbing onto the global innovation map. Although the latter is far more desirable than the former, the current state of events does not indicate that the industry is turning in that direction. Regardless of what path is followed, the availability of skilled labour and world-class manufacturing facilities, progress in Research and Development (R&D), the managerial capabilities of Indian pharmaceutical majors, favourable industry outlook, etc., multiply to create an enviable future for the industry, given the plight of other industries the present economic scenario. Page | 154

At the end of the day, no matter what strategies one adopts, the future of will be unpredictable. As Dr. Daniel Vasella, Chairman and CEO of Novartis AG rightly said “We can never read the future. You can put in place all the elements that you believe are essential: The people, the money, the technical resources, the skills, the continuous training, alliances with academia and with other partners…but there is no guarantee for success. You are constantly dealing with uncertainty. But having said that, you need to have people who are willing to bet their life that what they are doing is right. That’s when you have programs that move forward and succeed, but then you also have more programs that move forward and don’t succeed. It’s a business with more failures than successes. It’s just the fact and we have to accept it.”

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9.0 PRELIMINARY REFERENCES 1. Angell, M. The Truth About the Drug Companies: How They Deceive Us and What to Do About It. Random House. August 2004. 2. Barry, P. Ads, Promotions Drive Up Drug Costs. AARP Bulletin. March 2002. PhRMA. Research and Development. Retrieved on September 2004 from <> 3. Public Citizen’s Congress Watch. America’s Other Drug Problem. Dated 2002. Retrieved April 2003 from <> 4. Rowland, C. An insider turns against drug industry. The Boston Globe. September 2004. 5. Research paper on “Critical Challenges & Issues in Patent Documentation”by Ashutosh Nigam (Asst Professor, Dept of Management Studies,Vaish College of Engineering, Rohtak) 6. Drugs and Pharmaceuticals: International Pharmaceutical Industry-A Snapshot,Jan 2004, ICRA 7. Presention by Jerry A. Rosenblatt, PhD on“Predicting 2008: Global Pharma Market Forecast” Global Practice Leader, Forecasting &Opportunity Assessment November 14, 2007 8. Uwe Perlitz (April 9,2009) India's Pharmaceutical Industry course for globalization 9. Manjeet Kripalani (March 25, 2008) Indian Pharma: Hooked on the Hard Sell published in Business week, March issue, Volume 9 4th issue 10. Ray AS, Chakravorty M. Access to new drugs in India: Implications of TRIPS” 11. A guide to pharmaceutical patents; Volume I and II - Carlos M. Correa 12. Roadblocks on the pharmaceutical competition highway: Strategies to delay generic competition. Duke Law and Technology Review - 2008 Symposium Series. 13. (full report). 14. (Executive summary). 15. ISDB “Declaration on Therapeutic Advance in the Use of Medicines” Paris 15-16 November 2001. 16. Price Waterhouse Coopers "Pharma 2020: the vision: which path will you take?" 2008 17. “About ICH – Structure of ICH” 18. Joint open letter from 18 organisations ““Patient information” by pharmaceutical companies comes up against almost unanimous opposition from civil society” 19. 20. 21.

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A project report on The Pharmaceutical Industry Project 155  

A project report on Page| 1 DECLARATION Page| 2 ACKNOWLEDGEMENT Page| 3 1.7 Current Environment ...............................................

A project report on The Pharmaceutical Industry Project 155  

A project report on Page| 1 DECLARATION Page| 2 ACKNOWLEDGEMENT Page| 3 1.7 Current Environment ...............................................