Pharma pricing policy - A boon or a bane?

Alarm bells for the Indian pharmaceutical sector have started ringing on the advent of the the National Pharmaceutical Pricing Policy 2011 (NPPP). We tried to understand the intricacies of this policy and present the our analysis in the following article.

The NPPP has been drafted with an aim to make pharmaceutical drugs more affordable for the consumers, particularly the masses. In the 1994 Pharma policy, a total of 74 bulk drugs were brought under the regulatory framework based on economic considerations and the market share of the drugs.

Prices were calculated based on the lowest common denominator, which restricted them to the lower end of the price spectrum and hence curbed the competition in the industry. However, the new policy is essentially based on the the National List of Essential Medicine (NLEM), which includes 348 high priority drugs. Drugs manufactured by foreign pharma companies will also be considered under this regulation.

Also, formulations will be considered under the new policy, instead of bulk drugs. The new regulation will also consider ceiling prices around market level prices.

According to the NPPP report, the size of the Indian pharmaceutical industry is about Rs 1 lakh crore, of which Rs 48.2 thousand crore comes from the domestic market. The drugs in the NLEM list contribute around 29,000 crore or 60 per cent of the total domestic market share.

The price discovery mechanism will consider the stockists' prices for the top 3 formulations. These prices will be increased by 16 per cent for the retailer’s margin. The drug prices will also be revised annually, to adjust for inflation and manufacturers will be allowed to revise the prices, subject to a maximum price ceiling.

If the prices increase at a rate of 15% or the WPI rate in a year, NPPA has the right to reduce it for the next 12 months. Drugs which are not in the list, will attract regulatory pricing if their prices increase by over 10 per cent in a year, provided they are among the top 3 brands and have a market share of 20% or more with an annual turnover of more than 1 cr.

We have done some calculations using the above data. In our assumptions, one particular product has an annual turnover of 1000 units. The market is dominated by 3 players, who have a collective market share of 66 per cent. These three players are also the market leaders in terms of price.

Now, when we took the weighted average prices (WAP), we found that the ceiling price of the drug remained lower than that of the top brand. In our opinion, this price control mechanism will create an artificial equilibrium.

As the prices will remain lower for the top manufacturers, margins will get hit for the top brands. However they could also gain the max market share as doctors & patients would jump on the branded drug bandwagon. Other manufacturers, who may be able to increase the prices up to a limit, will most likely lose market share.

Beside, due to lower profitability, companies will be cautious before launching new molecules in the market. The government has also not cleared its stance on patented drugs.

In our opinion, companies will become more aggressive and hence competition will be inevitable pushing profitability down. Even though small manufacturers will enter the market, majority share will remain with bigger companies. This will also impact the FDI flows into the pharmaceutical sector.

It should be noted, that prices of pharmaceutical drugs will shoot up under the new policy. The motto of bringing prices seems to be out of sync with the intended outcome. The new policy will not benefit the Indian pharmaceutical sector.

The policy is yet to be approved and investors should wait till the next month, when the government meets to further discuss the policy.