Because big pharmaceutical companies are currently saddled with excess capacity in their home markets, any uptick in global demand would seem helpful in putting that capacity to work. But a wide range of mitigating factors including local production requirements in many emerging markets, varied supply chain and distribution paradigms, different regulatory and legal climates, etc., suggest that trying to meet emerging market demand from mature market facilities will prove unsustainable. Rather than simply shipping goods from Europe or the U.S. to Asia or Latin America, multinational pharma companies will need to develop global, holistic operations strategies that reflect the highly varied market dynamics at play in different parts of the world. They will have to be flexible and nimble enough to adapt to ever-changing conditions in various countries.
START PLANNING NOW
The time to start planning for this changeover is now. Winding down production facilities with excess capacity, ramping up new capacity in emerging markets, revamping supply chains, and mastering new distribution models is a multi-year undertaking.
Growth in emerging markets—and the implied shift of pharmaceutical product volumes from mature markets toward markets like India, China, and Latin America—pose challenges to big pharma operations networks and strategies, including deciding what multinational pharmaceutical companies must do to adapt.
THE NEW HOME FOR GROWTH
In the pharmaceutical industry, the defining difference between emerging and developed markets is the speed with which their appetite for prescription drugs is growing. Developed economies are still home to most of the world’s demand for pharmaceuticals, accounting for 80% of sales on a U.S. dollar basis, according to IMS. But sales in developed economies are projected to grow at only about a 2% average annual rate over the next few years, whereas sales in emerging markets are projected to expand at a 13 percent annual pace. By 2016, IMS forecasts, emerging markets will account for about 30% of sales on a dollar basis.
Because of lower pricing levels and a stronger focus on generics in developing economies, the disparity in growth will be even greater on a volume basis. China and (to a lesser extent) Brazil, in the coming years, will remain the largest markets in these developing economies, followed by Russia, India, Turkey, Mexico, and Venezuela.
Beyond the speed with which they are growing, emerging markets differ significantly from mature markets in terms of their market dynamics and infrastructure; their health systems and customer requirements; and their legal, regulatory, and economic policy climates. All these differences present challenges for pharma companies accustomed to operating in mature markets.
MARKET DYNAMICS AND INFRASTRUCTURE
Unlike mature markets, which are characterized by a well-developed infrastructure and an established pool of pharmaceutical manufacturers in a saturated market environment, emerging markets are characterized by rapid growth and volatile market dynamics that are difficult to predict.
This creates a high level of uncertainty from a demand planning perspective. Still very much in the development stage, emerging markets are home to many new competitors—often local players with much lower cost structures—that are positioning themselves in the marketplace. Emerging markets must also contend with a patchwork of distribution networks that differ dramatically from one country to another, adding to the complexity of managing various supply chains in parallel. Many of these distribution networks are highly fragmented, involving not only wholesalers, pharmacists, and physicians but also multiple intermediary wholesalers and third-party repackagers. Consider:
• China alone has more than 13,000 participants in its multilayered distribution system. Although the Chinese government has adopted policies aimed at consolidating the marketplace, a two-tier system is expected to remain in place. The first tier distributes product to cities and the second then delivers product to the countryside.
• The infrastructure in the Indian market is both underdeveloped and complex, a reflection not only of its multitude of wholesalers/pharmacies and their business partners but also two additional layers of distribution: clearing and forwarding agents, and “stockists.” This complex infrastructure, combined with the vast size of the country, poses major challenges to international pharmaceutical companies seeking to tap into the Indian market.
• In Latin America, distribution systems differ from country to country. The resulting complexity is compounded by a lack of stability in local labor markets, which makes the creation of specialized distribution networks difficult. Brazil alone has more than 350 distributors, and the top three control less than 40% of the market.
The complexity of these supply/distribution chains has led to increased risk of counterfeiting, fraud, and parallel trade. An estimated 15% of the drug supply is counterfeit in emerging markets, and the figure rises to more than 50% in parts of Africa and Asia. In China alone last year, investigators uncovered more than 14,000 cases of fake medicines valued at about $26 billion, leading to the arrests of more than 20,000 individuals.
Parallel trade, in which traders buy products for a low price and export them to countries where they can command a higher price, is also on the upswing globally. In some cases this is encouraged by government support. With more countries offering low prices on the horizon, parallel trade will further squeeze profits from multinational pharmaceutical companies.
HEALTH SYSTEMS AND CUSTOMER REQUIREMENTS
Developed markets enjoy mature healthcare systems and insurance programs that promote the consumption of healthcare. Among the 34 countries in the Organization for Economic Co-operation and Development (OECD), healthcare expenditures equate to 9.5% of gross domestic product. Widespread insurance coverage helps to support higher price levels.
In developing markets, by contrast, most publicly funded components of healthcare are chronically under-resourced, and patients pay a high percentage of their medical costs out of pocket. All this keeps pressure on pharmaceutical prices. So does the widespread use of local generics. Consumers are also accustomed to purchasing prescription drugs in smaller packs with fewer pills and no-frills packaging. This simultaneously pressures pharma manufacturers to keep prices low, even as they bear the expense of a more complex product portfolio with a higher number of SKUs.
LEGAL AND REGULATORY CLIMATE
Mature markets typically provide strict enforcement of patent and counterfeit protections, and federal regulators tightly control access to the marketplace. The picture is quite different in emerging markets. Patent protections tend to be enforced less rigorously, and some countries, including India, Malaysia, and Thailand, have compulsory licensing protocols that require patent owners to license their technology to competitors.
Of high relevance and impact for operations strategy is the fact that in many emerging market countries, governments require or strongly incentivize local manufacturing as a key element for market access. A few examples:
• China provides preferential pricing and reimbursement for locally produced drugs, and purchases Type 1 vaccines only from local manufacturers in certain regions. Local Chinese governments often provide tax relief and other subsidies to companies that invest locally.
• Public institutions in Brazil give a price preference to local manufacturers when soliciting tenders. The Brazilian government awards contracts with volume and price guarantees up to five years in length for drugs that come from multinational companies willing to transfer technology to the Brazilian government. The State also provides funds for expansion, productivity improvements, and regulatory compliance to local pharma manufacturers.
• Russia gives preference in government tenders to locally manufactured products, requires vaccines in the National Preventive Vaccinations Calendar to be produced locally, and has designated 57 drugs that must be produced locally by 2020. The country has also created venture funds aimed at helping local companies produce drugs that are currently imported.
HOW PHARMA OPERATIONS EXECS NEED TO RESPOND
To meet the new operations requirements demanded by emerging market dynamics, multinational pharmaceutical companies will need to alter key elements of their technical operations strategies. Among the imperatives:
1) Develop an overall product supply and manufacturing network strategy that reflects shifting demand for pharmaceuticals, while ensuring adequate manufacturing capacity and access to markets where local manufacturing is required. At the moment, the majority of the world’s pharmaceutical manufacturing capacity sits in mature markets, often in the form of inflexible facilities designed for high-margin, high-volume products. In developing new manufacturing capacity overseas, companies will have to decide whether to build or buy, enter into a joint venture, or outsource to contract manufacturers. The right approach for each company will depend on a variety of factors, including the company’s size and its ability to finance a new facility, its areas of expertise (is production one of them?), and the availability of suitable acquisition targets, which is limited in some markets. It is very difficult, for example, to find companies or manufacturing plants in Russia that fulfill multinational quality standards (e.g., good manufacturing practices, FDA site approval). Among other things, companies will need to be mindful that the economic and political risks in some countries may be detrimental to long-term investments in those locales. Also, the cost of building new facilities in emerging markets may not be defensible for some companies given that the industry already suffers from excess capacity on a global basis.
For companies considering the contract manufacturing route, the outlook is reasonably positive. Contract manufacturing of pharmaceuticals is on the upswing, and contract manufacturers have been investing in emerging markets by commissioning new facilities, buying local manufacturers, and forming strategic alliances with local makers.
A number of big pharmaceutical companies have already begun to redesign and right size their networks. Pfizer, Novartis, and GlaxoSmithKline have all closed multiple plants in mature markets in recent years and plan further exits. Merck intends to reduce its manufacturing network from 91 to 77 facilities. At the same time, many of these companies are investing in and building a presence in emerging markets. Novartis has built greenfield manufacturing plants in Russia, Brazil, and Singapore, and Sanofi-Aventis has done so in Vietnam. Merck is opening a facility in Hangzhou, China, to package medicines for China and the Asia-Pacific region; it also is doing joint ventures in China and India. And Amgen has acquired facilities in Turkey. This is only a partial list, and yet there remains significant excess capacity in developed markets and a need for more capacity in emerging economies.
2) Design end-to-end supply chains tailored for different markets and their unique requirements. For many companies, maintaining multiple, differentiated supply chains tailored to individual markets will become the norm, supporting increasingly complex product portfolios with more SKUs. Supply chains for different market, product, and customer segments in emerging markets, relative to mature markets, look very different in terms of agility, service level, and cost. Across the board, effective cost controls will be essential to meeting the higher pricing pressures typical in emerging markets.
3) Increase supply chain transparency to better understand and deal with volatile demand patterns and reduce surprises and out-of-stock situations. Along with improved transparency, companies should improve their understanding of product flows and strengthen track-and-trace capabilities to address rising counterfeiting and parallel trade risks.
4) Rethink and adjust distribution models to reflect regional and local requirements. Companies will need to build out and embrace country- and region-specific distribution networks. Here again, some leading companies have already started. In China, Sanofi-Aventis is developing distribution models that bypass Tier 1 distributors and go straight to regional distributors for better control of market access. GlaxoSmithKline is using Good Supply Practice (GSP) licenses to distribute imported drugs in China, collaborating with distributors who are focused on distinct regions, and leveraging regional Tier 2 and Tier 3 distributors.
5) Build out capabilities in complexity management. Increased complexity is an inevitable component of the rise of emerging markets, and with it come the various market requirements that the operations functions of big pharma companies must cover. Multinational pharma companies must be able to win with complexity rather than be overwhelmed by it. Levers that come to mind are platform and postponement approaches, standardization in packaging, and multi-language country packaging, to name a few.
THE RIGHT RESOURCES MAKE IT HAPPEN
Succeeding in this new, globally more complex environment, and making the adjustments to operations strategy described above, will require the right resources and talent, including people with direct experience and expertise in emerging markets—people with innovative operations insights and capabilities.
The growing demand for pharmaceuticals in emerging markets presents multinational pharmaceutical companies with remarkable opportunities. The challenge from an operations perspective will be in executing the changes to the operation setup necessary to seize those opportunities. The time to begin is now.
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