Taking advantage of globalisation, many companies leveraged cost arbitrage and competence to build scale. Two sectors which benefited significantly through exports were information technology and pharmaceuticals.
The last couple of decades saw the emergence of a new breed of companies, such as Infosys, TCS, Sun Pharma and Dr Reddy’s, that did business in many countries across the globe. For instance, Sun Pharma’s net sales grew almost 16 times - from ₹1,737 crore in 2005-06 to ₹27,744 crore in 2015-16. It is among the top five in the global generics space and holds the top slot in the Indian pharma market. The company now serves over 150 markets worldwide, and has around 50 manufacturing facilities across six continents with over 30,000 employees.
Such companies need to ensure that they comply with the local laws of the countries in which they operate. But financial statement compliance seems to be accorded higher priority than operational and product compliance. Such firms had now acquired a greater business focus but had to grapple with a multitude of risks — accounting and financial reporting, currency, technology and quality standards.
Currency risks can be managed — not eliminated — through hedges. For instance, in 2015-16, Dr Reddy’s had to deal with a sharp devaluation of the rouble, and its Russian revenues fell 29 per cent. It also had to take a significant write-down as the economic crisis in Venezuela unfolded and a repatriation cap of $4 million was imposed. But the firm still recorded 4 per cent top-line growth that year, though its PAT was down about 10 per cent.
Poor compliance is bad business
Quality standards, however, need constant monitoring. Any slack can result in erosion of competitive advantages. Non-compliance can hurt, especially when the regulator has the power to ban products.
In the US, pharmaceutical products are regulated by the federal drug regulator, the US Food and Drug Administration (US-FDA). The FDA is responsible for protecting public health by assuring the safety, effectiveness, quality and security of human and veterinary drugs, vaccines and other biological products, as well as medical devices. The regulator has the authority to inspect facilities outside of the US as well.
Many companies which report a larger share of revenue from exports did not seem to position compliance as being central to corporate strategy. For instance, in 2016, the US-FDA’s Office of Manufacturing Quality issued warning letters to five Indian firms. In 2015, eight firms were issued such letters, while in 2014, six firms faced the flak.
What do such warning letters imply? Depending on the gravity of the violation, firms may lose their licence to export all or select products manufactured from those facilities. While it may be possible to “site-transfer” products to other locations, it is a time-consuming process. Filing of abbreviated new drug applications (ANDAs) and drug master file (DMF), which are critical to growth, can stall as well. Remediation and re-certification can stretch to a well over a year. Regaining market share becomes difficult as competitors quickly capitalise on the gap and fill in.
The way forward
Such action by regulators has now brought the focus back on compliance. The US market is just too big to ignore. Over the next five years, over $92 billion of branded drugs are expected to go off-patent. By 2020, the US market share of global medicine spend is expected to be around 40 per cent. With the country running budget deficits, federal and state spending on healthcare will remain under pressure.
Indian companies will continue to be key beneficiaries of the US demand. Over the last ten years, Sun Pharma’s R&D expenses as a percentage of sales have been in the 6-13 mark. Cumulatively, the company had 413 ANDAs approved, while 159 await US-FDA approval. Dr Reddy’s spent around 12 per cent on R&D over the last two years. As of March 2016, 82 generic filings were pending approval. In the last year the company filed eight DMFs and the company had 768 cumulative filings.
Improving compliance and moving up the value chain will continue to be key differentiators. Firms focussing on filing ANDAs and DMFs, branching into high-value products such as biosimilars, or creating specialty therapies such as those for oncology and respiratory diseases, and undertaking contract research and manufacturing (CRAMS) can capitalise on such growth opportunities. Constructive R&D spending can work wonders for a pharma firm’s profile.