Major mergers and acquisitions activity was predicted throughout the 1990s and early 2000s. The reasons were clear.
In 2003, the top 10 players accounted for only 40 per cent market share, next 60 for around 50 per cent, and the remaining 290 for the balance 10 per cent. With relatively no product differentiation and similar business models and approach, consolidation to gain share seemed to be the natural progression.
But, in fact, the market saw increased fragmentation with the top 10 players accounting for only 36 per cent in 2007, the next 60 accounting for 49 per cent, and the remaining 400 for only 15 per cent!
Other than a few multinationals exiting the market and one or two local acquisitions by local companies in the late 1990s/early 2000s, the prophecy of a mass wave of consolidation remained a mirage. The reasons why it did not materialise are a mix of business fundamentals and cultural factors.
Growth and profitability - "No burning platform" - Unlike other industries (for instance, cement) fragmentation had not led to severe reduction in profitability and growth.
With a booming economy and population, the Indian pharma industry has recorded one of the fastest rates of growth over the last 10 years and most companies have experienced profitable growth. Hence the burning business need to consolidate was absent.
Value drivers - "Show me the money" - Most companies operated on similar business models, had the same kind of products, similar field force reach which met the same doctors. There were no clear value differentiators in the domestic market which could have justified the value premium. Multinationals were exploring organic routes of growth.
The only driver could have been investments in plants for exports to regulated markets and R&D for the future - but with a huge rise in exports experienced by everyone, there was no risk of excess capacity creation which needed consolidation.
Cultural factors - "I built the company" - A significant barrier to merge or acquire was the sense of identity the promoter families had with the company. Almost all Indian companies are promoter family driven with high involvement of running the company being the norm rather than the exception. Many of these were run by legendary first generation entrepreneurs who had created these companies out of exceptional "rags to riches" stories.
Selling the company was akin to parting with one's own life work. Hence it was very difficult for promoters to take a sell-off decision which led to the cultural inhibition in mergers and sell-off.
The game changers
So what's changed now? For starters, the environment outlook for domestic pharmaceutical players has changed - the product patents era, increasing attractiveness of India as a market for multinationals and competitive pressures in price realisations of exports. Importantly, many of the cultural factors are shifting as well. This has resulted in reversing some of the fundamental factors which inhibited consolidation earlier.
Reduced growth due to lower new product introductions: Traditionally, the bulk of the growth for the domestic pharmaceutical players come from new products. These include products which are launched for the first time in India as well as "combinations" of existing products. With the adoption of product patents, Indian players can no longer launch "first in India" products on their own. Only innovator companies can do this and Indian companies would need to license with them in case they wish to launch the product. The number of combinations is also expected to reach a peak and there is increased scrutiny on "irrational combinations". The initial signs are clear the number of new products launched in the past two years has actually dropped 3 per cent from the previous two years instead of growing as in previous years.
Multinationals look at tapping value from emerging India: Poor pipelines and increased generic threats have forced multinationals to look at emerging markets for growth. India provides a growing and profitable market as well as a hub for R&D and manufacturing for the world. Multinationals who wish to leapfrog and get a strong presence in the Indian market will increasingly look at acquisitions for growth.
Portfolio approach by NextGen entrepreneurs: The recent announcement by a Japanese major of acquiring one of India's largest pharmaceutical companies is a true game-changing event. It has shed the old taboos associated with "selling the family jewels" and has opened up a floodgate of potential opportunities. Unlike their parents, the next generation of entrepreneurs seems to view the business from a portfolio approach and is open to sell-off if it is not in line with the overall risk/return profile.
Crystal ball gazing
So what does the future hold for the pharmaceutical industry in India? It is always tricky to make predictions on things which are likely to unravel in your own lifetime. There are likely to be two types of consolidation in the Indian industry.
Acquisitions of Indian companies by multinational companies: This is likely to be more prominent. Multinational companies are increasingly likely to view acquisition as a route to enter/expand their presence in the Indian market. With deep pockets, patent protected products, and with the acquisition of Indian players, deep reach in the country, innovator companies are likely to become a potent force in the Indian pharmaceutical industry in the future.
Mergers among Indian companies: Indian companies would increasingly look at merging among themselves to pool resources and take on the challenges the multinationals pose. These mergers would be necessary to eliminate duplication in investments in field force, manufacturing and R&D and thus retain share.
Are we ready?
While it is clear that the pharmaceutical industry is headed for consolidation, it is not really prepared for it.
Thus far Indian pharmaceutical companies have been seen as "acquirers" and never really been acquired. Even in their global acquisitions, Indian companies have always adopted a "string of pearls" approach, never really integrating the acquired company into the parent company but treating it as a largely stand-alone entity.
Indian management and employees are not experienced in facing the challenges of a post-merger integration and the associated cultural fit issues.
This wave of consolidation is being kicked-off by non-Indian companies. Many of these companies are themselves end-products of a wave of mergers over the last two decades in the innovator pharmaceutical space.
At present, Indian pharmaceutical companies are reactors, and not actors in the game.
In the future, Indian companies will need to get their act together and become more pro-active. They need to actively identify right fit partners whether in the Indian industry or abroad and initiate the consolidation rather than wait till too late. The winner is likely to be the company which has the foresight to merge/acquire and create a "value-enhancing" partnership rather than the one which chooses to "go it alone".
The implication on the employees working in the Indian pharmaceutical industry cannot be underestimated. The future pharmaceutical executive needs to be not just market savvy but be adaptable to changes in company ownership and culture.
Post-merger integration will be the single most critical activity if "business as usual" is to be maintained while achieving merger objectives. The key would be to retain the "secret sauce" of success of both the companies while losing the flab (and not the other way around!).
Sriram Shrinivasan is lead pharmaceuticals practice, Accenture India. He has more than 10 years of experience in advising clients in areas such as business diagnosis, entry strategy, and operational excellence and has worked with pharmaceutical companies based out of the US, Europe and India as well as with innovator and generic companies.