History of Bulk Drug/API Industry in India

Pharmaceutical Bulk Drug/ API Industry: Trends & Outlook

History of Bulk Drug/API Industry

 Summary

The API outsourcing trend within the global pharmaceutical industry remains intact as pharmaceutical companies are increasingly looking to maintain focus on core competencies, access new technologies, preserve capital and ensure multiple sources of raw material supply. However, API suppliers in Europe and US are facing increasing pricing pressures due to presence of low cost providers in developing markets, excess big pharma capacity, and backward integration by certain generic companies.

China remains a dominant player in the global bulk drug industry given its large scale manufacturing capabilities, cost leadership and sufficient availability of intermediates due to strong technological capabilities in fermentation. However, quality concerns as reflected by instances of product recalls due to contamination continue to hamper the ability of Chinese manufacturers to source bulk drugs to advanced markets.

The domestic bulk drug industry is poised to benefit from the impending patent expiries in the regulated markets (including many blockbuster drugs) leading to increase in generic penetration; thereby providing a significant opportunity for supply of APIs to manufacturers of such generic drugs coupled with increased outsourcing of bulk drugs by multinational pharmaceutical companies.

The surge in DMF fillings by domestic pharmaceutical and bulk drug companies reflect the growing presence of Indian manufacturers in the regulated markets. The growth is underpinned by heightened regulatory compliance amongst Indian companies with numerous US FDA approved manufacturing facilities, large talent pool and low cost of manufacturing.

The role of Indian bulk drug manufacturers in the global pharmaceutical supply chain is gradually evolving with increasing presence in synthesis and manufacture of late stage intermediates and APIs. Traditionally, innovators have frequently opted to perform final stages of API synthesis in-house or partner with specialised European suppliers while outsourcing early stage intermediates to Indian manufacturers. However, in recent times, the reputed track record of Indian companies in supplying quality products coupled with complex synthesis capabilities has enabled increasing participation in supply of late stage intermediates to innovator companies.

In an attempt to gain greater control over bulk drug supplies, large domestic pharmaceutical companies are increasing backward integration in key API segments. In addition to the apparent benefits of greater cost efficiencies and quality control, in-house API manufacturing facilities offer greater manufacturing flexibility and minimises the reliance on third party suppliers. The increasing backward integration is expected to continue in light of greater participation by domestic pharmaceutical companies in the highly competitive US generic market which could impact the business potential for bulk drug suppliers.

Profitability in bulk drug manufacturing is primarily driven by scale of operations. Pricing power remains limited owing to significant cost pressures from the end user segment coupled with considerable competitive intensity. As a result, companies prefer to focus on manufacturing a smaller basket of APIs, thereby offering sufficient volumes in order to achieve economies of scale and protect operating margins. However, ICRA notes that this strategy often results in a narrow therapeutic/ product coverage amongst most bulk drug players, leading to associated business concentration risks.

Increasing instances witnessed of pure play bulk drug manufacturers entering into manufacture and marketing of formulations in an attempt to move up the value add chain. Some API manufacturers are also looking to enter into manufacture of generic drugs for the advanced markets through the filing of ANDAs by targeting dosage intensive formulations wherein percentage of the API is high, in order to leverage upon their strong in-house manufacturing capabilities.

The low profitability and return on capital employed (RoCE) of bulk drug players relative to pharmaceutical formulation companies underscores the capital intensive nature of operations and high working capital intensity owing to maintenance of high inventory and elevated credit terms demanded by customers.

Overall, a diversified product mix and stable pipeline of APIs; ideally a balanced mix across various stages of development is critical to long term sustainability. In-house or collaborative efforts for differentiated technologies, continuous improvement in operating efficiencies and high capacity utilisation are paramount.

Industry Structure

Active Pharmaceutical Ingredients (API) or bulk drugs are the principal ingredients for finished pharmaceutical products. Intermediates are the compounds from which active pharmaceutical ingredients are prepared. APIs cannot be administered directly to the patient, and other inactive substances called excipients are added to stabilise the mixture. This end product, which includes the API and the excipient, is referred to as a formulation. Formulations are the pharmaceutical products administered to patients and can take the form of tablets, capsules, syrups, ointments, creams, injectables, etc.

The global API market can broadly be divided into regulated and semi regulated markets. The semi regulated markets offer low entry barriers in terms of regulatory requirements and intellectual property rights. The highly regulated markets, like the United States and Europe, have high entry barriers in terms of intellectual property rights and regulatory requirements, including facility approvals. As a result, there is a premium for quality and regulatory compliance along with relatively greater stability for both volumes and prices.

The regulatory process by which API manufacturers generally register their products for commercial sale in the U.S. and other similarly regulated countries is via the filing of a Drug Master File (DMF). DMFs are confidential documents containing information on the manufacturing facility and processes used in the manufacture, characterization, quality control, packaging and storage of an API. The DMF is reviewed for completeness by the FDA, or other similar regulatory agencies in other countries, in conjunction with applications filed by finished dosage formulation manufacturers, requesting approval to use the given API in the production of their drug products. For European markets, companies need to submit a European Drug Master File (EDMF) and, where applicable, obtain a certificate of suitability (CoS) from the European Directorate for the Quality of Medicines.

Global API Industry

Continuous asset review at large pharmaceutical companies is a sign that outsourcing trend remains intact

The demand for outsourced services within the global pharmaceutical industry remains intact as large pharmaceutical and biotechnology companies continue to outsource the development and manufacturing of APIs in order to focus on core priorities, access new technologies or additional capacity, preserve capital and ensure multiple sources of supply. Furthermore, many emerging pharmaceutical and generic drug companies outsource all process development and manufacturing and many larger pharmaceutical companies have publicly stated that they will increasingly outsource the manufacturing of drug products.

In recent years, drug manufacturers in advanced markets namely Europe and US have been facing increasing competition from developing nations given their capabilities in API manufacturing and finished dosage form drugs. While overall global demand for pharmaceutical products has benefited from the rapid growth in certain developing markets, the presence of manufacturers within these markets, who have lower cost structures, have resulted in downward pricing pressure throughout the pharmaceutical supply chain, and especially on generic APIs and certain development services for clinical phase products. Going forward, ICRA expects the downward pricing pressure to continue in the API segment and believes that regulatory compliance, product quality, pricing, and logistics will determine the extent of the long term impact of the low cost Asian competitors in the global bulk drug industry.

However, the pricing pressures, due to developing market competitors, on later stage clinical projects and supply arrangements for patented products have been limited to date, although these pressures may increase as developing markets become more acceptable as suppliers to larger pharmaceutical companies. As a result, the ability of API suppliers to the advanced markets to partner with innovators at an early stage of drug development gains greater importance. In certain cases, once an innovator chooses a particular API supplier for use in a drug manufacturing process, it is unlikely that they will later switch to a competing alternative since obtaining the regulatory approvals needed for a change in the manufacturing process is time consuming, expensive and uncertain. Accordingly, if an API supplier is unable to partner with an innovator early in its manufacturing design phase, it limits their ability to recover late-stage opportunities wherein the supply volumes are often higher.

China remains the largest manufacturer of bulk drugs in the world aided by large scale manufacturing capabilities and Government support

Over the years, Chinese API manufacturers have integrated themselves into the global supply chain for both innovator pharmaceutical and generics companies worldwide and are no longer limited to merely supplying intermediates and commoditised bulk drugs. China’s leading position within the global bulk drug market has been driven by cost leadership (lower than India) and large scale manufacturing capabilities in certain product segments such as antibiotics and vitamins. Additionally, in comparison to India, Chinese API manufacturers also benefit from China’s extensive presence in intermediates with strong technological capabilities in fermentation, thereby ensuring ample availability of raw materials. The strong manufacturing capabilities coupled with greater regulatory compliance and improving intellectual property (IP) protection has helped Chinese manufacturers increase supplies to regulated markets.

However, the global perception of sourcing bulk drugs from China continues to be impacted to an extent by quality concerns such as the instance of recall of heparin by the US FDA due to contamination of the API imported from China. In an attempt to overcome these challenges, the Chinese State Food and Drug Administration (SFDA) is seeking to release a new GMP guidelines for manufacturers. Given China’s strong manufacturing capabilities and growing presence in supplying APIs to the regulated markets, the ability of Indian manufacturers in developing and manufacturing niche APIs will be critical in differentiating their presence in the global stage.

Domestic API Industry

Impending patent expiries and greater generic penetration likely to provide growth opportunities for domestic bulk drug manufacturers

The merchant API industry in India has traditionally catered to the domestic as well as export markets with their supply largely restricted to manufacturers of generic drugs. This is because sourcing of APIs for patented drugs is maintained in-house by majority of the innovator companies in order to maintain greater flexibility and quality control. As the patented drugs near the end of their exclusivity, innovator companies gradually begin outsourcing of APIs in order to achieve greater cost efficiencies in light of the consequent entry of generics.

Over the next three years, a number of drugs are set to lose their patent protection in the developed markets also referred to as patent cliff, including several blockbuster drugs. Given the impending patent expiries and the subsequent increase in generic penetration in the developed markets, the outsourcing of APIs is likely to increasingly shift to low cost manufacturing destinations such as China and India. This is because, on patent expiry, drug prices generally witness a 90%-95% fall as generics begin to enter the market. As a result, in order to remain competitive, innovator companies are increasingly looking to partner with low cost API suppliers either through outsourcing contracts or long term alliances. Recently, AstraZeneca has indicated that they will seek to outsource a large majority of their bulk drug requirements over the next eight to ten years, primarily from China and India, in order to maximise cost efficiencies. As part of their strategy towards outsourcing, AstraZeneca has sold its manufacturing facilities located in France, Italy and Spain and closed its main API production facility in the UK.

Evolving presence of domestic bulk drug manufacturers in the global pharmaceutical supply chain

The role of Indian bulk drug manufacturers in the global pharmaceutical supply chain is gradually evolving with increasing presence in synthesis and manufacture of late stage intermediates and APIs. Innovator companies have traditionally preferred to perform the final stages of API synthesis in-house or partner with a small group of European suppliers while relying of Indian suppliers for early stage intermediates. In recent years, as Indian bulk drug manufacturers have gradually begun to offer higher quality APIs coupled with low developments costs and complex synthesis capabilities, innovators have started to source late stage intermediates from India and in some case have formed partnerships with domestic manufacturers. However, given the fairly risk-averse profile of innovators with regards to outsourcing, the role of European bulk drug manufacturers such as Lonza and DSM in partnering with innovators for supply and synthesis of late stage APIs is expected to remain prominent in the near future.

In the case of generic pharmaceutical companies, the outsourcing of APIs and late stage intermediates to China and India is well established as intellectual property protection is less of a concern as compared to patent holders. Furthermore, in contrast to innovators, generic companies source APIs from Indian manufacturers more frequently given the substantial cost pressures faced in the highly competitive generic market. The leading generic companies today have developed strong expertise in patent challenges, unique formulations and are investing heavily in shortening the time period for generic patent challenges in order to capture first to file opportunities. As a result, bulk drug suppliers are required to be more dynamic, innovative and responsive to meet the evolving needs of customers. In fact, in many instances, bulk drug manufacturers work closely with generic pharmaceutical companies in API synthesis well before patent challenges are filed.

High therapeutic/ product concentration due to focus on manufacture of smaller basket of APIs to ensure economies of scale

Since the merchant API industry faces significant cost pressures from the end user segment coupled with considerable competitive intensity in certain mature bulk drug segments, a majority of the manufacturers prefer to focus on a smaller basket of APIs. Such an approach offers sufficient volumes to ensure economies of scale thereby helping manufacturers protect their operating margins. However, ICRA notes that this strategy results in high product concentration and narrow therapeutic coverage for a majority of the pure play bulk drug manufacturers which adversely impacts their business profile. Realising the need to diversify, some of the merchant API manufacturers are looking to enter into the relatively less mature therapeutic segments such as oncology, CNS, and CVS; wherein the competitive intensity is relatively lower.

production. In addition to increasing the process efficiency and product yields, this technology helps decrease the overall environmental impact. In February 2010, Dishman Pharmaceuticals and Chemicals Limited entered into a similar collaboration with Codexis for use of the biocatalyst technology. The ability of bulk drug companies to develop and implement new and differentiated technologies will help strengthen manufacturing capabilities and provide a competitive edge over peers in sourcing to generic and innovator companies.

Increasing backward integration by domestic formulation companies in order to maintain greater flexibility and cost control

In recent years, many of the large domestic pharmaceutical companies such as Lupin Limited (Lupin) and Dr. Reddy’s Laboratories (DRL) have increased backward integration into bulk drugs especially for some of their key product segments in order to maintain control over quality and costs. Furthermore, with many of the domestic pharmaceutical companies present in the highly competitive US generic formulation market, the requirement for in-house API supply is gaining prominence. In addition to the apparent benefits of greater cost efficiencies and quality control, in-house API manufacturing facilities offer better manufacturing flexibility and minimises the reliance on third party suppliers. While a majority of the bulk drug manufacturing capabilities of the large Indian pharmaceutical companies are meant for in-house consumption, the surplus production capacities are generally utilised for sales to third parties and has resulted in some companies gaining a sizeable market share. For instance, over the years, Lupin has managed to attain global leadership in manufacturing of certain product segments belonging to the cephalosporin (third generation antibiotic), anti-TB and CVS segments.

The importance of backward integration into bulk drugs is further highlighted by the substantial API manufacturing capabilities of some of the leading global generic players such as Teva and Mylan. In addition to sourcing a majority of their API requirements from in-house facilities, Teva is also amongst the leading global suppliers of APIs to third parties (though it accounts for only ~4% of its revenue) for both generic and branded customers. In an attempt to vertically integrate its operations, Mylan acquired Matrix Laboratories - a leading supplier APIs for the manufacturing of anti-retroviral (ARV) drugs, which are utilized in the treatment of HIV/AIDS in 2007.

Increasing instances of pure-play bulk drug players foraying into generic formulations through filing of ANDAs

In an attempt to move up the value add chain; there have been increasing instances of pure play bulk drug manufacturers looking to enter into manufacture of formulations. Some API manufacturers are also looking to establish themselves in generic drugs in the advanced markets through the filing of ANDAs. In such instances, companies target dosage intensive formulations (wherein percentage of the API is high). As a result, these companies are able to leverage upon their expertise in manufacturing the API thereby enabling them to compete in the generic market. While entering into manufacture of generic drugs in the advanced markets, it is likely that these companies will look to tie up with established pharmaceutical companies in order to limit costs associated with litigation and leverage upon their strong distribution network.

In contrast, however, some of the pure play bulk drug manufacturers continue to focus solely on supply of APIs to formulation companies in order to maintain their non-compete stance. These companies find it unviable to compete with the same formulation companies to whom they supply APIs. Some of the global pharmaceutical companies tend to prefer sourcing APIs from companies which are only engaged in the manufacture of APIs as against those which also compete with them in the generic drug market.

Financial profile of bulk drug companies characterised by low Return on Capital Employed (RoCE) and extended working capital intensity

In comparison to pharmaceutical companies engaged in manufacture and marketing of formulations, the profitability of bulk drug companies is lower owing to competition and overcapacity in certain mature segments leading to severe pricing pressure. Furthermore, the capital intensive nature of operations and extended working capital cycles have resulted in suppressed RoCE for a majority of bulk drug players. The high working capital intensity is a result of maintenance of high inventory of intermediates given the heavy dependence on China and stretched receivables position due to the lenient credit terms demanded by customers. For bulk drug companies targeting the advanced markets, ICRA expects the working capital intensity to be lower given the more favourable credit terms expected from pharmaceutical companies in these markets.

Annexure 1: List of ICRA Rated Bulk Drug Companies S.