Saturday, June 30, 2007

 

Surviving in the patents regime

Businessworld

VISHAL KRISHNA AND ABHISHEK CHOWDHARY



With patent regime on one side and over 10,000 peers on the other, India’s small- and medium-sized pharma companies are caught between the devil and the deep sea. Those with revenues in the Rs 100 crore-500 crore range have been groping for a viable business model to stay afloat even as they endure pricing pressure from peers and large pharma companies, who have the economies of scale to their advantage.

Most of them have been weak-kneed since 2005, when the patent regime came into effect. But they may find inspiration in a handful of those that have reinvented themselves and are now able to keep their heads above water. Companies such as Arch Pharmalabs and Unimark Remedies, both based in Mumbai, have outperformed the industry benchmarks (see ‘Ahead Of The Pack’) and are on their way to becoming large corporates.

If Arch Pharmalabs hit upon the survival mantra by narrowing its portfolio of 10 products to just three active pharmaceutical ingredients (APIs, which are used in the manufacturing of drugs), Unimark found its bearings in managing alliances with other pharma companies for exports. At the bottom of the pyramid, Acharya Chemicals, a Rs 30-crore firm, has redefined itself from being an API supplier to a contract research firm.

As a whole, small-to-medium enterprise (SME) pharma companies aren’t doing badly. Those with revenues of between Rs 100 crore and Rs 500 crore have grown 20 per cent in revenues, while their profits have grown by more than 40 per cent in the last two years. In comparison, the entire pharma industry reported revenue growth of 22 per cent in two years and net profit growth of 44 per cent in the past two years.

Somewhere in this growth lies their survival mantra. Their strategies indicate that mid-cap pharma companies are playing it smart and that entrepreneurs are getting smarter. Arch Pharma’s turnover rose to Rs 364 crore in 2007, up 47.4 per cent since last year. Its net profit rose 46 per cent to Rs 23.17 crore. Unimark’s turnover shot up to Rs 450 crore in 2007, a growth of 46.6 per cent over 2006. Unimark’s net profit details are not available since it is still auditing its accounts.

The Survivors

In 1999, three entrepreneurs — Ajith Kamath, Manoj Jain and Rajendra Kaimal — acquired a loss-making SME company, Merven Drugs, for Rs 16 crore and renamed it Arch Pharmalabs. “Scientists think everything is gold,” says Kamath. “But we had to turn the company around and so we homed in on three products.” He and his partners stuck at it and pruned down the number of chemicals manufactured by Merven Drugs from 10 to just three. Two core APIs — Atorvastatin and Clopidogrel — and one penicillin side chain, Isoxazole Penicillins. These three were shortlisted because there were no competing vendors in India. Market conditions helped since their rivals in Europe were not as competitive on price points and quality. Today, about 60 per cent of Merven’s market is now in the US, a key factor that helped the trio dodge all troubles and achieve their goal of profit.

“Since we were a financial firm, there were people who doubted our capabilities to survive in the pharma space,” says Kamath, who is also the chairman and managing director of Arch Pharmalabs. “But no one expected Arch to grow the way we did.” The company was struggling between 1999 and 2002. In 2002, the old chemical firm posted a net loss of Rs 2.18 crore. The turnaround began in 2003.

Like Arch, Unimark has also reinvented itself. Started in 1983, Unimark was a marketing firm for large pharma and chemical companies till 1995, when it entered the API manufacturing space. Most thought that it was a wrong move for a marketing firm, says Mehul Parekh, executive director, Unimark Remedies. But Unimark could afford to do so since its marketing team knew the products that were in high demand in the industry — they had an edge over the others.

But as Unimark’s API business grew, it faced competition from smaller firms. So, it had to reinvent itself yet again to cut manufacturing costs. “We created alliances with our competitors,” says Mehul. The alliance team would go to competitors and ask them to manufacture those products that Unimark no longer could on a large scale. They then entered into a profit-sharing agreement for the sale of such APIs. Unimark would exclusively market this API abroad. The model worked best with an API called Nimesulide, a pain management product. As a move up the value chain, Unimark has, so far, filed eight patents and its exports constitute more than 60 per cent of its revenues.




Now, both Unimark and Arch are preparing for larger challenges as drug prices are getting cheaper at the consumer end. Since original drug manufacturers (ODMs) are squeezing API price margins, SMEs are feeling the pinch. Through process patents they have combated price erosion in the market. Patenting processes means that the engineering process or the heating process of the chemical reaction can be patented. For example, the heat treatment in the reactor could be re-engineered to produce the same chemical at double the capacity. This activity has brought down the project cost by 35 per cent for Unimark. A similar process was followed by Arch.

Some firms have thought of diversification. Smaller firms such as Acharya Chemicals have bigger ambitions. Acharya, too, works in the API and clinical trial materials space, but it has identified its future in contract research. Initially, it was working with only one, giant Swiss pharmaceutical firm Roche, but in 1999 it realised that its core strength was in chemistry.

“Drug discovery companies have outsourced their compounds to us and based on our research work, we share the intellectual property,” says Anand Acharya, director, Acharya Group. For an SME like Acharya Chemicals, 85 per cent of its business is export-oriented. This SME manages everything from discovery to commercialisation, so it has created a core research team comprising 15 scientists. Similarly, Arch has spent more than Rs 10 crore on research and development and Unimark has pumped in Rs 20 crore for the same. The other major issue for SMEs is the monthly cost of hiring PhDs. For that matter, finding an experienced PhD to guide a team is a challenge. Every year, the employee cost has been growing higher. But these SMEs see a good reason to spend on talent and have made profits even with rising costs.

The Road Ahead

When SMEs fall, they fall hard. Take the case of Morepen Laboratories. In 2002, the company took a huge bet on marketing and manufactured ‘loratadine’, a drug for hay fever. It expected the drug to become a prescription medicine but the plan misfired. Loratadine became an over-the-counter drug. The company had raised huge money to market and manufacture the drug in the US, raising over $100 million (Rs 480 crore then) through bank loans and deposits in 2002. When the sales plunged, the company’s depositors were irate.

Currently, Morepen is restructuring its business and paying off its debts by issuing fresh capital to the tune of 10 per cent to equity investor Standard Chartered Private Equity. Entrepreneurs have learnt from such incidents and top SMEs have begun to adhere to corporate governance standards. They have also actively sought the help of private equity investors.

Arch Pharmalabs has gone through four rounds of funding and 59 per cent of its stake is held by private equity players. Swiss Tech-BTS, a private equity firm, has a stake in both Unimark and Arch Pharmalabs.“There will be consolidation in our space over the next three years and private equity firms will play a major role in the industry,” says Kamath. These firms will no longer remain small firms.

The challenge for mid-cap companies will be to bring in more funds and this is where the race for growth and survival will determine who will remain ahead in the regulatory and environment space.



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