As a company founded and overseen by A.V. Rama Rao, one of India’s best-known chemists, Avra Laboratories is a popular choice for the hundreds of chemistry students graduating each year in Hyderabad. Unfortunately for the company, it is also a popular hunting ground for other contract research companies that have mushroomed in the city. Rama Rao thus had to reckon with a high employee turnover every year, as the contract research industry in India has grown rapidly over the last decade. ‘They just disappear,’ says Rao, ‘without even bothering to give a letter of resignation.’ Things were different a year ago. Avra did not lose even one employee.
Low employee turnover, however, is among the few positive trends facing the Indian contract research organisations (CROs). Global trends have been largely unfavourable to this industry, and some of these have got little to do with the economic slowdown. Indian services companies now have to deal with the diminishing outsourcing work that accompanies the slowdown, but they have to also face increasing competition from China and a damaged reputation in the West. Consolidation and restructuring in large pharma companies is another worry, which is compounded by the declining drug pipeline of the industry. After enjoying more than a decade of unbelievably good fortune, the Indian contract research industry has suddenly flown into a storm that could make survival difficult except for those with financial muscle and a long term vision.
Chemistry and drug discovery services companies in India are thus busy looking for long term growth rather than short term contracts. They are looking at developing end-to-end skills rather than specialising in one discipline like custom synthesis, either under one company or through strategic partnerships with other Indian companies. In the process they are forced to move slowly away from low risk business models, where the customer pays for some of the costs and provides assured returns, to a higher risk model where they have to spend money to develop a partnership whose returns are not always assured in the beginning. Says Goutam Das, chief operating officer of Syngene, a large CRO in Bangalore: ‘We are now more keen to develop long-term contracts.’
The Indian contract research industry was born in the mid-1990s. It used the country’s reputation for innovative chemistry to start businesses providing custom synthesis of drug and chemical molecules. Companies like Syngene, Chembiotek in Calcutta, GVK Biosciences, and Jubilant Chemsys – all of which were initially funded by other large groups – grew rapidly in the beginning, but were also joined by a large number of small companies that quickly began undercutting each other. Margins, which were more than 50% in the beginning, began to slowly drop with competition but still remained good enough for most companies to remain in business.
The business model was almost exclusively based on providing pharma companies with Full Time Equivalents (FTEs), industry jargon for people who worked in another location in another company. It was a low risk model because money was paid every month, and there was enough new business to keep the facilities and people fully occupied even if some customers pulled out.
Indian companies faced tough competition all these years from Chinese companies, but the overall outsourcing pie was big enough for them not to worry much about the Chinese. With the economic slowdown, things began to change. However, it was the consolidation and restructuring in the global pharma industry that hurt more than the slowdown. In the last year, the industry has seen several large takeovers: Pfizer taking over Wyeth, Merck taking over Schering-Plough and Roche taking over Genentech, to name a few recent examples. Apart from these takeovers, large pharma companies have also been restructuring. Pfizer, for example, restructured creating small independent units within the company. GlaxoSmithKline created new Drug Performance Units (DPUs) within its Centres of Excellence for Drug Discovery (CEDD). Each DPU operated in one location in one therapeutic area.
All of this restructuring and consolidation created uncertainty for Indian CROs. Consolidation supplemented by the slowdown made people change or lose their jobs, breaking links for Indian companies. Several contracts disappeared with the people, and new ones were not forthcoming so easily. ‘We have not signed a new contract in the last three months,’ says Rama Rao. Consolidation created even bigger uncertainties. GVK Biosciences in Hyderabad has a large contract with Wyeth, with around 200 GVK scientists working for Wyeth, but after the takeover it is not certain how this deal will go forward. ‘Wyeth is in a freeze at the moment,’ says GVK Biosciences president Manni Kantipudi.
On the other hand, the biotechnology companies are not in a good situation either, as they have struggled to find continued VC funding. Indian CROs work more with pharma than biotech, but some existing biotech contracts have been put on hold. So in this situation, Indian companies have begun to be affected by competition from China. Companies in China have developed a better reputation with the large pharma companies. Pfizer and AstraZeneca have both announced large deals with Chinese companies, and these moves have affected Indian contract research companies. ‘China has taken a big lead over India,’ says Kantipudi. The Chinese government encourages companies to invest their profits in China itself, by taxing money that is taken out of the country, which creates more business for Chinese companies. Indian ceos privately admit that the Chinese work ethic is superior to that of Indians.
These problems are making a noticeable impact on the Indian contract research industry. On the one hand, many ceos feel that FTE kind of research might slow down in the next few years. So they are all busy creating more long term deals and partnerships (C&I 2009, 1, 23). A large number of CROs are now barely able to survive, thus creating conditions for a consolidation in the Indian industry. Some larger Indian companies are actively looking for smaller companies to buy with complementary skills; some are even scouting in China for acquisitions.
Since the pharmaceutical industry is interested in more end-to-end outsourcing, companies in India are trying to be end-to-end players either by investing themselves in new facilities or through partnerships. Avra, a pure chemistry company, is now negotiating with some possible partners in biology. THINQ, a small company based in Mumbai, had developed expertise in early stage process chemistry but has arrangements with Natco and Unichem for scale up. GVK Biosciences has tied up with the German company Crelux for structural biology work and the Chinese company Excel PharmaStudies for joint clinical research. ‘It is difficult for Indian companies to develop expertise in biology because the subject is not well developed in the country,’ says Rama Rao.
In recent times, Indian companies have not had a good reputation with the US Food & Drug Administration (FDA). Six months ago, the FDA banned Ranbaxy – India’s largest pharma company – from importing 30 generics. The FDA has found, after site visits, that Ranbaxy’s plant at Paonta Sahib in North India did not follow good manufacturing practices. The regulator is also saying that Ranbaxy falsified data on its drug applications. This could be brushed off as an isolated case, but some companies are citing this case in their arguments against outsourcing from India. Says Mukund Chorghade, president of THINQ, and a consultant in Boston, US, helping companies outsource to India: ‘I have to now work harder at convincing people about the India advantage.’
Even unrelated fraud revelations have had an effect. The founder ceo of Satyam Computers, a large information technology services company based in Hyderabad, had to leave the company because he siphoned off profits. This made at least one European company cancel its pharma outsourcing contract with GVK, another Hyderabadbased company.
The Indian pharmaceutical industry is going through one of the most difficult periods in its history. Exports have not grown significantly, and exports to the US have declined dramatically in the last six months. Ranbaxy, India’s largest pharmaceutical company, made a net loss of $156m in the last quarter. It also said that it expects a loss of $150m this year. The Indian industry’s exports to the US from October to the end of February fell by 40%. This was for several reasons: the fall in the value of the rupee, the ban on Ranbaxy and increasing competition from China and Korea. In fact, Indian companies are now losing market share to China and Korea.
On the other hand, drug discovery programmes of the large companies have used up large amounts of money without any providing results for a decade and a half. Many leading pharma companies are on the verge of trimming down or closing in-house drug discovery programmes. These companies will now focus either on in-licensing molecules from the US and Europe or on joint research. So the Indian pharma industry is undergoing a big shift in drug discovery from the big companies to the smaller players, represented mostly by the CROs. The current turmoil in the contract research industry has thus come at a most critical period in its evolution.
Observers in India have no doubt about the longterm viability of the contract research industry in the country and the future of the larger companies. But current events have caused many companies to rethink their strategies, and to go from contracts that provide a lab and a set of trained people to riskier but more valuable long-term contracts. It is a trend that could reshape the outsourcing industry landscape in the country in a few years.