Given that even companies operating from very low cost countries still need to invest in their businesses, the obvious question is why any generics producer would actually supply products under the Dutch preference policy (or to the German tenders, or to the UK pharmacy chains, or to many others low-price markets). Problems with lack of product availability in the Netherlands suggest that the answer is that sometimes they don’t, but mainly it seems to be a mixture of the need to cover manufacturing overheads by driving volume, and cross-subsidies from other countries – the aforementioned ‘basket’ approach. The question of whether the European generics industry should be carrying the level of capacity that forces it to offer rock-bottom prices in tenders is worthy of a discussion of its own, but here we focus on the industry’s approach to pricing. Talking about biosimilars in the emerging markets, Rich DiCicco of Harvest Moon said that when he tendered for business in Egypt, he found that the innovator of the product that he was trying to sell cut its price to below his production costs. His initial instinct was to withdraw, but then he decided to treat the whole African region as one and accept losses in Egypt in the hope of making profits elsewhere. This is a perfect example of what many companies do, both within and between countries in Europe, but in our view, it is a slippery slope that is likely to result in a permanent reduction of industry profitability.
The fundamental flaw in the basket approach is that, for it to work properly, it requires prices to be able to move both up and down, so that price declines in one market can be balanced by increases in another. In a few markets, such as the UK, this is actually the case but in most, prices are capped and generally only go down. Consequently, once prices have been cut, producers are largely trapped at the lower price level. If a company is selling across 30 markets, having one or two with very low prices is bearable, but as the number of low-price markets increases, it becomes harder and harder for the remaining territories to make up the difference. Thus, low prices in the UK, the Netherlands and France, which have been the reality for a long time, were historically compensated for by a better situation in Germany, Spain and Italy. Today, the Netherlands is worse than ever, Germany has tenders for all high-volume molecules and Spain has seen swingeing price cuts. This has left companies with a disproportionate emphasis on the few parts of the European continent where prices remain high, with the biggest contributor by far being Russia.
Interestingly, the EGA meeting was held two weeks after the Adam Smith Russian Pharmaceuticals Congress in St Petersburg, a get-together that is attended by executives of almost every pharma company operating in the country. In general, the atmosphere in St Petes was rather more positive than in Malta, since the Russian market is continuing to grow strongly and offers huge potential given the level of under-treatment of many common diseases. But even here, there were signs that regulatory change may be coming.
Although the Adam Smith conference is not set up with any particular theme in mind, one usually emerges and in 2012, it was the prospects for the introduction of substitutability in what is currently a fully branded market. At present, branded generics are supported by the fact that a) the vast majority of pharmaceutical expenditure comes from the pockets of patients and, b) there genuinely are differences in quality between the various brands of a given molecule on the market, owing to Russia not yet having adopted EU GMP standards (due in 2014). However, the Federal government does finally appear to be moving towards the introduction of some form of general health insurance, which would cover the needs of a far broader swathe of the population than is currently eligible for the DLSO programmes that are administered by the regional governments. Along with health insurance will come an increased focus on INN prescribing and on the products on the EDL (essential and vital drug list). These already have their prices registered and any price increases limited, but under a health insurance system, they are likely to experience forcible price harmonisation, probably via a reimbursement system that only covers the cost of the cheapest and requires patients to make co-payments for more expensive choices. Fortunately, Russian patients are already used to paying for medicines, so it is reasonable to assume that they would be ready to co-pay for better quality brands, but other countries have moved from unlimited co-pays to a capping system, so overall, we would expect the result to be a decrease in prices.
In fact, irrespective of how government policy may or may not develop, INN prescribing is already rising rapidly in Russia and companies such as Teva are responding by pushing the ‘generic generic’ approach. We are also seeing the emergence of local companies that specifically target the DLSO, where INN prescribing has been mandatory from the start (and where a combination of low prices and corruption makes participation relatively unattractive for the global majors). For the shareholders of companies such as Krka, Richter and Stada, which derive a big proportion of their sales from Russia, this trend is masked by the overall growth of the market, which means that sales in both the INN and the branded segment are going up, and by the fact that investors have no INN players against which to compare the branded companies. In addition, there are signs that some branded companies are making their sales growth look better than it really is by pushing stock into the distribution chain, even though this can never be more than a quick fix (and, indeed, can create a vicious cycle whereby the extent of the build-up has to be increased each year in order to sustain the appearance of growth – Stada’s previous experience in Serbia is a text book case of this). Our conclusion from all this is that Russia, while remaining an excellent market, is already not quite as good as it looks and is at considerable risk of price and margin contraction in the coming years.
The future outlook for Russia merely reinforces our view that it is a mistake to try to balance out bad markets with good ones, since even the good ones are not necessarily going to remain good for ever. As Emile Loof from Teva argued, it would make more sense to lobby governments to take low-priced drugs out of the reimbursement system altogether, allowing companies to raise prices to a more sustainable level and (although he didn’t say this) create a branding opportunity in what are currently unbranded markets. In any event, it is time for companies to abandon the basket approach and to strive for adequate returns in every market, before the industry drives itself out of business.