Emerging Patterns of Innovation in Pharmaceutical Manufacturing in India: Expectations from Liberalization and Implications for Industrial Upgrading

The share of contribution of sales of goods towards total income for domestic firms grew from 62.4 to 67.25 per cent (Table 3a). The share of income from trading and rent, other sources[r]

Emerging Patterns of Innovation in Pharmaceutical Manufacturing in India: Expectations

from Liberalization and Implications for Industrial Upgrading 1

R John & D Abrol

The Indian Pharmaceutical Industry is one of the growing industries in India, accounting for 3.1

to 3.6% of global industry in value terms as well as 10% in volume terms India exported pharma products worth Rupees 411.3 billion (US $ 6.4 billion) during April-September 2017 India has 10,500 manufacturing units and over 3000 companies India has the largest number of USFDA approved manufacturing units outside United States India’s cost of production is nearly 33 % lower than that of the US; Labour costs 50-55 per cent cheaper than in US and EU The cost of setting up a production plant is 40 per cent lower than in US and EU

While the challenge of upgrading API manufacturing looms large, many large Indian pharmaceutical firms are shifting to move to branded and difficult-to-make generics for the export

to regulated markets as their new longer-term investment The future of generic pharmaceutical industry is dependent on the secure supply of APIs But the legacy of post-2000s policy continues

to hold back the government from taking the next big step In the mainstream view the post-TRIPS period of Indian pharmaceutical industry and the coevolving changes in the conduct and performance of domestic firms seen as accelerating industrial and technological upgrading Large domestic firms are seen as becoming cost competitive They are seen as increasing investments to improve exports to regulated markets They are seen as strengthening their in-house research and development capabilities for drug discovery and new product development During the post TRIPS period of 1997-2016, in the mainstream view it is characterized as a phase of radical institutional change and the framing of continuing with the post-TRIPS policy path is getting reinforced while the need of the hour is to make radical changes

1 This is a draft version of a paper the authors are currently working upon and therefore it is not be quoted The work

is based on a project report submitted to the Indian Council of Social Science Research, New Delhi, January 2018 The project was sponsored by ICSSR

Companies are not looking at APIs as a matter of national security and pharma companies look at the commercial picture They are all doing what brings them quick money In shutting down drug discovery, the competitive path Indian pharma has chosen is to move to branded and difficult-to-make generics It is fully understandable that large firms within the domestic industry are rethinking the direction of pharmaceutical R&D and innovation after a period of two decades The challenges of upgrading of API manufacturing looms large The future of generic pharmaceutical industry is dependent on the secure supply of APIs But the legacy of post-2000s policy is continuing to hold back the government from taking the next big step Drug discovery and new drug development R&D programmers have also tapered off The inability of private investment of large domestic firms to sustain the allocation of financial resources for the risky activity of drug discovery and new drug development is now well apparent There are only three programmes under perusal in the industry with the help of private investment

The low road to industrial upgrading, wherein the focus was on targeting short run cost competitiveness, has taken the domestic firms away from investing in a systemic way in the technological and industrial upgrading activities in the pharmaceutical industry In table 1, if we look at total number of ANDA’s approved during the period 2009-2018, the US FDA approved a total of 5350 with Indian companies approvals holding a share of 34.43 per cent The share of approvals to Indian firms during this decade remained on an average of 34.35 per cent Among the tentative approvals granted, Indian companies had a share of 38.17 per cent and during 2009-2018 the average share of tentative approvals granted was also around 38 per cent

Table 1: US FDA Approvals of ANDAs, 2009 to 2018

Year ANDA's Approvals Indian Cos approvals Tentative Indian Cos

During the post TRIPS period the Domestic firms were focused on the immediate challenge of registering drug master files (DMFs) and abbreviated new drug applications (ANDAs) to meet the regulatory requirements of US, UK and EU markets Competencies required for technological upgrading with regard to continuous manufacturing were not on the radar of either the industry or the policymaking community The low road to industrial upgrading taken during the period of last two decades is eventually hampering the productive structure, the global efficiency of the industry, the environmental and energy management efficiency and the long run competitive thrust of domestic firms

It is argued that the road taken did not focus on achieving structural competitiveness Therefore, our assessment of the post-TRIPS period would have to include the analysis of emergence of structural rigidities and institutional voids impacting on the development of capabilities for production, investment and innovation Pharmaceutical manufacturing is hollowing out on account

of the low road taken to industrial and technological upgrading by the domestic private sector firms and the public sector Learning, capability building and innovation making processes need to be seen as a historical outcome of building structural competitiveness India cannot remain

competitive in the long run without improving structural competitiveness

Structural competitiveness is essentially about achieving "the strength and efficiency of a national economy's productive structure the global efficiency of the national economy, proficient and flexible structure of industries, the rate and pattern of capital investment, its technical infrastructure and other factors determining the "externalities", economic, social and institutional frameworks and phenomena which can substantially stimulate or hamper the productive and competitive thrust

of domestic firms" (Chesnais 1986:86-87)

The research objective and focus of this study relate to making an investigation in to the 1) nature and extent of participation of foreign and domestic firms in active pharmaceutical ingredients (APIs) and formulation pharmaceutical manufacturing, 2) the coevolving relationships between them and their nature of interaction with small firms through the routes of outsourcing, contracting, takeovers and integration into global pharmaceutical production and innovation network and 3) the emerging implications for learning, innovation and competence building The nature of innovation system

failures vis-a-vis the challenge of competence building, technological and organizational learning, and innovation making are identified with a view to redefine the priorities of policymaking for pharmaceutical manufacturing

a patient run strategy in which they may have to sacrifice short-term gains in favor of term rewards However, moving beyond the delineation of challenges facing the domestic pharmaceutical companies, Dinesh Abrol, et al (2013) urged the scholars to take note of how their outward foreign direct investment (OFDI) learning connections are not helping much the firms to overcome the innovation limits Argument was advanced that the sub-optimal conditions are in making for the conduct of drug discovery and development in India

long-The current situation is that large domestic firms are unable to continue drug discovery with their own in-house efforts in India for almost any type of market need in respect of drug discovery and new drug development Foreign firms are limiting themselves to exploiting the existing market and production and have no interest in the development of local technological capabilities2 Analysis undertaken of R&D and patent portfolios of the leading domestic pharmaceutical firms

at different points of time shows that it is not easy for domestic pharmaceutical industry to continue simultaneously with innovation making investment across all the relevant domains of pharmaceutical innovation (See Dinesh Abrol, et.al, 2011, 2013, 2016, 2017)

Large domestic pharmaceutical firms have started to import their bulk active pharmaceutical ingredients (APIs) requirements from China wherein the domestic regulators do not go to even inspect manufacturing facilities (Boston Study, 2015) Large domestic pharmaceutical firms’ in-house R&D and innovation making efforts continue to be embedded in the understanding that they need mainly the contributions of foreign acquisitions, alliances and collaborations, export market and are satisfied with the enhancement of merely fiscal support for the strengthening of firms’ in-house R&D efforts (Dinesh Abrol, et al., 2011, 2013, 2016 and 2017) Differding also confirms that the post-TRIPs pathways chosen were not good enough to sustain the competitive edge of domestic pharmaceutical firms in respect of drug discovery(Differding, 2017)

Framework for Analysis

Below we give the analytical framework chosen with a view to explore the changes underway in the structure, conduct and performance of Indian pharmaceutical industry during the period of 1997-2016 In this study, the proposed analytical framework chose to address the study of co-

evolution of following three dimensions 1) changes in the market structure (a firm is attempting

to compete or become involved in markets where the market structure compels a firm to adopt in one or another manner the pathways of outsourcing and contracting and form alliances and

collaborations), 2) changes in the competencies for production and innovation (a firm is

attempting to augment, transform or further leverage its set of competencies in one or another

manner) and 3) changes in the network economics (a firm is attempting to compete in conditions

influenced by the economics of network effect)

Understanding industrial structure

The dimension of changes in the market structure involves an understanding of the historically

evolving environmental, institutional and competitive factors impacting on the development of industry and market This dimension includes the study of reasons for the changes taking place in industry structure (ownership structure, relations between large and small firms, interactions between foreign and domestic firms and role of public sector or state-owned enterprises), positioning (firm strategies for market development and income), and institutional issues that impact competition Further as governmental intervention has played an important role in respect

of the development of policies and institutions impacting on the promotion and regulation of

investment of private sector this dimension is studied with regard to the impact on the structure of manufacturing

Learning, competence building and innovation

The dimension of changes in the competencies for production and innovation involves

understanding the manner in which the firm makes internal decisions regarding the competencies

it develops in-house, which competencies it chooses to source through partners, and which competencies it might leave for the market to provide In this study, this dimension refers to the development of their contribution to the system building through the pathways of outsourcing and contracting of manufacturing and the development of in-house competencies for local manufacturing of active pharmaceutical ingredients (APIs) and pharmaceutical formulations

Economics of network effects

The dimension of network economics refers to the considerations arising out the structure of

demand for final goods and supply of factor inputs that influence the dynamics of industry or market under consideration Though earlier the dimension of network economics could be collapsed into the market structure dimension without any loss of explanatory power, but the presence or absence of strong network economic effects on a market exerts such a strong influence

on the formation of firm networks that it requires today its own categorization This dimension includes all of the issues associated with the field of economics, such as the demand-side

economies of scale, the modes of growth, the scope of strategic alliances and collaborations, the

specificities of national and international context, the value chain under development and the positive and negative feedback loops being experienced in the process of co-evolution of the different dimensions of development of industry, sector, economy and society

Analysis

As on September 30, 2017, in the CMIE database, the total number of pharmaceutical companies is

786 The number of firms not reporting income from 1997 to 2016 is 98 These companies have been

excluded from the analysis Types of companies not included are: companies involved in producing capsule cases, veterinary, ayurvedic and homeopathic medicines, etc (Table 2)

Table 2: Decile-wise Number of Pharmaceutical Companies in the Study Sample

Source: Author’s calculations based on CMIE data dated 30th September 2017

Post-TRIPS Pathways to Income Development

Analysis of the pathways to income development confirms the structural embeddedness of the Indian pharmaceutical industry in the changing conduct of large domestic pharmaceutical firms In table 2

we see that the share of income of large domestic firms of Decile 1 representing the top fifty (50) firms segment was 43.45 per cent during 1997–2006 During 2007–2016, this share, representing top fifty-two firms of Decile 1, rose to 60.22 per cent The share of income of domestic companies, which reported income in both decades from Decile 1 numbering 47 companies, rose from 43.3 to 57.8 per cent between the two decades See Table 3 covering the analysis of income of close to over six hundred firms for which relevant information could be extracted from the CMIE database for the period of two decades

Table2: Pattern of industry wide distribution of sources of income

Decile Company Origin reported total income in the No of companies which

Notes: Companies included in count; No of companies which reported total income in the I decade,

484; No of companies which reported total income in the II decade, 503

Table 3: Industry Wide Distribution of Sources of Income (Rs in Million)

Total Income 3116807 (100) 13716524.1 (100) Sales of Goods 2604543 (83.55) 11162088 (81.38)

Income from Non-financial Services 349558.1 (11.22) 1321731 (9.64) Income from Financial Services 58380 (1.88) 570973.4 (4.16) Income from other sources 64916.6 (2.08) 534539.4 (3.10)

Source: Author’s calculations based on CMIE data dated 30th September 2017

Table 3a: Domestic Firms Distribution of Sources of Income (Rs in Million)

Total Income 2224546 (71.37) 11060931.2 (80.64) Sales of Goods 1945230 (62.41) 9225220 (67.26) Job-work Income 10649.2 (0.34) 38366.7 (0.28) Fiscal Benefits 16330.8 (0.52) 70396.1 (0.51) Income from Non-financial Services 173071.9 (5.55) 854390 (6.22) Income from Financial Services 39966.2 (1.28) 458005.5 (3.33) Income from other sources 39398.1 (1.26) 414553 (3.02)

Source: Author’s calculations based on CMIE data dated 30th September 2017

Table 3a: Foreign Firms Distribution of Sources of Income (Rs in Million)

Income from Non-financial Services 176486.2 (5.66) 467341 (3.41)

Income from Financial Services 18413.8 (0.59) 112967.9 (0.82)

Income from other sources 25618.5 (0.82) 119986.4 (0.87)

Source: Author’s calculations based on CMIE data dated 30th September 2017

Analysis is made in terms of the contribution to income obtaining from industrial sales, trading and rent, and financial services during the period 1996–2016 The good news is that even today the income of pharmaceutical industry comes primarily from the conduct of industrial activity Although the contribution of financial activities to income is on the rise (it was 1.88 per cent during 1997–

2006 and rose to 4.16 per cent during 2007–2016), when we compare the impact of finalization on the Indian economy as such the contribution of financial activities to sources of income is still not a matter of concern in the case of Indian pharmaceutical industry

During the period 1997–2006, eighty-three (83.5) per cent of the income of this industry came from the sales of goods During the decade of 2007–2016, the contribution of sales of goods was reduced

to eighty-one (81.3) per cent The contribution to income from the share of sales of goods declined only marginally The share of income from trading and rent, financial activities, and income from other sources is not significant It has remained within the range of 14 to 18 per cent

During the period 2007–2016, the contribution of trading income was on the rise for domestic firms The share of contribution of sales of goods towards total income for domestic firms grew from 62.4

to 67.25 per cent (Table 3a) The share of income from trading and rent, other sources, and financial activity grew more in the case of foreign firms than domestic firms During 1997–2006, the share of contribution of job-work income was 0.34 per cent (Table 3a) During 2007–2016, the share of contribution of job-work income came down for the industry to 0.28 per cent(Table 3a) Coming to the aspect of market shares, during 1997–2006 the share of foreign firms in total sales was 21.5 per cent (Table 3b) During the decade of 2007–2016, this share came down to 14.12 per cent

Post-TRIPS Pathways to Market Expansion

Analysis of the post-TRIPS pathways to market expansion utilizes the data obtaining from CMIE database on expansion realized by the industry through 1) domestic market sale, 2) export of goods, 3) export of services, and 4) import of finished goods See Table 4 for more details It indicates that the share of domestic market sales came down from 67.46 to 42.61 per cent On the other hand the share of export of goods had increased from 30 to 41 per cent Within this component it was noted that the contribution towards income earned through the expansion of domestic market for domestic firms was close to 50 per cent during 1997–2006 and this share got reduced to about thirty-five (34.97) per cent during the period 2007–2016 (CMIE prowess, 2017)

Table 4 : Pathways to Market Development by Firms during the Last Two Decades

Domestic Market Sales 1750459.2 (67.46) 5543808 (42.61)

Import of Finished Goods (cif) 35254.5 (1.36) 99653.7 (0.77)

Source: Author’s calculations based on CMIE data dated 30th September 2017

Sales of goods are the major source of income for a pharmaceutical firm However if we look at the breakdown of three major route (table 5) through which manufacturing is carried out, a major portion income generated from sales of goods comes from manufacturing for self since there has been a drastic shift from domestic market sales to export market In the case of domestic firms, there occurred a significant increase due to the contribution of the pathway of export of goods During 1997–2006, the contribution from income earned through the expansion of export market in the case

of domestic firms was 22 per cent This increased to 34.44 per cent during the period 2007–2016 The contribution of the share of the pathway of import of finished goods towards market expansion is on the rise after the implementation of TRIPS Agreement The import of finished goods

is connected to both the rise in the share of patented drugs and the weakening of manufacturing capabilities

The changing contribution of pathways to development of local production is first of all examined

in terms of changes underway in the relative shares of “manufacturing for self,” “manufacturing for others,” and “manufacturing through others.” Data available on the outsourcing of manufacturing jobs and the purchase of finished goods for marketing is computed to provide an estimate of the changing

magnitude of sales of goods using the pathway of “manufacturing through others.” The pathway of

“manufacturing for self” includes the share(s) attributable to in-house production for the sales undertaken in domestic and export markets The share of domestic market is computed as sales of goods minus the share of export of goods and export of services The pathway of ‘manufacturing for others” makes use of the data available on the export of services and the job-work income in CMIE database

Table 5 brings to light the evidence of how the route of “manufacturing for self” is reserved far more for the export market The share of pathway of “manufacturing for self” has declined from 69.45

to 38.69 per cent in the case of domestic market Sales in the domestic market are increasing via the route

of “manufacturing through self ”, export market

Table 5: Pathways of Manufacturing Undertaken by Pharmaceutical Companies

Manufacturing for Self Domestic Market 1247532.51

(69.74604103) (38.690338) 2976357.63 Export Market 508470.3

(28.42714686) (45.8254435) 3525244.691

(98.17318789) (84.5157815) 6501602.321 Manufacturing for

Others Export of Services (1.084130031) 19391.6 (14.6424888) 1126413

Job Work Income 9953.495

(0.556471989) (0.40473082) 31135

(1.64060202) (15.04721962) 1157548 Manufacturing

through others Purchase of finished goods Outsourced manufacturing 13.81152 10.47705

Source: Computed by the Author Notes: The Manufacturing pathways for self and for others were calculated

using cost of production method while manufacturing through others was calculated as ratios from sales

The share of firms adopting the route of “manufacturing for self” for the benefit of domestic market

is on the path of decline in the post-TRIPS period The study indicates that the sale of goods in domestic markets is becoming dependent on the pathway of “manufacturing through self” in the export market “Manufacturing through others” overall has seen a jump from 1.64 per cent to 15 per cent

In a separate study by the WHO there seems to be a considerable rise in the number of firms

embracing the two pathways of loan licensing and contract manufacturing The pharmaceutical

industry is moving away from the practice of undertaking manufacturing for self This is a matter

of concern because it can impact the development of in-house capabilities for production and innovation The WHO study, which only recently undertook a primary survey of close to 300 firms, confirms that just two manufacturers in every five (about 44 per cent) units are producing their own brands/products More than 50 per cent of the units are in contract manufacturing whether full or part Remaining are either contract manufacturers (13.9 per cent) or part time contract manufacturers (41.7 per cent) About 50 per cent of contract manufacturers are even exporters About 20 per cent

of contract manufacturers are keen to launch their own brand About 5.2 per cent who own a brand want to enter into contract manufacturing/tie-up/collaboration with large firms Small-sized firms are trying to survive using contract manufacturing and are looking for new pathways to become viable (WHO India, 2017)

On further analysing, larger-sized firms from Decile 1 and Decile 2, comprising close to 50 per cent

of the sample, used the route of “purchase of finished goods” to grow in the domestic market for pharmaceuticals (CMIE Prowess, 2018) While the route of “manufacturing for others” triggers investment in technological and industrial upgrading via the establishment of contract manufacturing organizations in the case of large domestic firms, the same cannot be said of the impact of the route

of “manufacturing through others for sales in the domestic market.” Data provided on the issuing of loan licenses by the drug licensing authorities of key states indicates a substantial rise in the number

The rise in share of export of services, representing the expansion of contract manufacturing of formulations and APIs for foreign clients, is another important development of the post-TRIPS period Today the expansion of manufacturing of formulations in different dosage forms for regulated markets by domestic pharmaceutical firms belonging to the first two deciles is the most important pathway by which large domestic firms are made to implement the cGMP (Current Good Manufacturing Practice) The role of domestic regulation is now only beginning to make a difference Together the increased shares of export of services and of the rising share of loan licensing and contract manufacturing confirm the tendency of the industry to move away from the pathway of “manufacturing for self.”

During the second decade of the post-TRIPS period, this change occurred rapidly because this is when the policymakers chose to globally integrate the pharmaceutical production system Leading pharmaceutical companies turned towards contract manufacturing and research services to expand their business Contract manufacturing for foreign clients has become an integral element of the

operational strategy of some important domestic firms Large firms that are into marketing formulations in the domestic market also started to use much smaller-sized companies for the

expansion of their domestic business In fact, the shares of pathway of “manufacturing through others” and “manufacturing for others” is even larger than what is shown in Table 5 The contribution

of companies registered as partnerships or other proprietary forms of ownership are required to be added to the information obtaining from the CMIE database

Neglect of the Public Sector

In the Annual Report of the Department of Pharmaceuticals for the year 2016-17 consolidated report of the five public sector medicine companies was projected as in the following table

Table 6: Status of state owned units

Employees 2000(in 1997) 11000 1992) (in 191(in 2013) 1467(in 1992) 712 (as on date)

Source: Department of Pharmaceuticals, Annual Report, 2016-2017

It shows that the Govt has started shifting its responsibility from prioritizing the public sector nearly by the advent of globalization and structural reforms inducted by 1990 Advancement of the public sector drug companies was either stalled or neglected to the extent that mismanagement and corruption creep in and later manifested in full bloom Therefore in line of the reform process which campaigns for abolition of public sector it was easy for the government to finish off this robust drug production public sector units

Concerns regarding OFDI

Based on the analysis of the RBI data now available on the post-2007 greenfield pharmaceutical patterns of OFDI suggests that the equity and loans component is not rapidly rising anymore The Indian pharmaceutical multinationals are depending far more on the component of guarantees issued to complete their international transactions See table7 for the details of period wise