A bitter pill to swallow

The Australian pharmaceutical sector commands an important position in the domestic economy. A knowledge-based, skill- and technology-intensive industry employing about 40,000 people, annual revenue currently totals about $22 billion.

Accounting for just over 1.0% of global pharmaceutical sales, the Australian pharmaceutical sector is within the top 20 in the world, based on pharmaceutical sales (it is currently the world’s 15th largest pharmaceutical market and the fourth-largest in Asia).

An important component of the pharmaceutical sector is the Pharmaceutical Product Manufacturing industry, which consists of about 150 local and multinational innovative and generic manufacturers employing about 13,400 people. The major pharmaceutical groups dominate the local industry, although only a small number are engaged in secondary or actives manufacture (active pharmaceutical ingredients). The bulk of industry players undertake the formulation or manufacture of final products through to dispensing and packaging and the fill and finish stage (a large number also restrict their activities in Australia purely to distribution).

According to Medicines Australia, there are 40 originator companies operating in Australia (mainly subsidiaries of the global pharma giants) and up to 10 generic companies. In 2008-09, the industry spent just over $1.0 billion on research and development (R&D), making it one of the most R&D-intensive manufacturing industries in Australia. The industry has a growing (albeit still small) reliance on new generation medicines and biologics, as pharmaceutical companies change their product focus.

Another key feature defining the local industry is the existence of the Pharmaceutical Benefits Scheme (PBS), through which the Federal Government subsidises the price of prescription medicines. While this scheme has boosted volumes, it has also led to a high penetration rate for patented pharmaceuticals as opposed to generic products, although steps are now being taken to balance the ratio. There were about 144 companies listed as suppliers to the PBS in 2009-10 and the top 20 suppliers accounted for 89% of the script volume.

With industry growth expected to be slightly below that of the general economy, IBISWorld anticipates that the industry will generate revenue of $9.38 billion in 2010-11, up from $8.38 billion in 2005-06. This will equate to an average growth rate of 2.3% over the five years through 2010-11 and a growth rate of 1.7% from 2009-10. In 2010-11, domestic demand will be worth an estimated $15.05 billion, highlighting the dominant role that imports play in the industry. While the industry is a net importer, with imported product satisfying about two-thirds of domestic demand, it is also one of Australia’s largest high-technology exporters. However, it is now feared that export growth will taper off partly as a result of the closure of a number of manufacturing facilities.

In the near term, the industry is expected to continue its gradual transformation process in view of slowing revenue growth, declining R&D productivity, increasing competitive pressures and rising safety concerns. Continued global industry rationalisation may also have implications for the level of pharmaceutical manufacturing and R&D undertaken in Australia.

The patent protections of some key drugs are due to expire between 2010 and 2012. This means that the pressure for change will escalate as major players lose exclusive manufacturing rights to some of the most profitable drugs in history. This will result in the adoption of new business models, as industry participants seek to evolve in order to ensure their continued survival.

Over the five years through 2015-16, growth in industry revenue is expected to average 2.6% per annum to reach an estimated $10.66 billion.

Industry outlook

The operating backdrop of the Australian Pharmaceutical Product Manufacturing industry has changed dramatically over the past decade, with further change expected as the industry seeks to transform itself to ensure survival amid new operating conditions.

Moderate economic conditions, an ageing population and changing community attitudes to health care will continue to drive industry growth. Ongoing innovation and the development of new products in various therapeutic areas will also fuel growth, as will the development of new specialist-driven therapies in unmet areas. The continued trend toward switching products from prescription to over-the-counter (OTC) status is expected to be another important driver for the industry over the five years through 2015-16. Another influential factor will be the growth in complementary medicines.

On the other hand, the effects of falling profit, patent expirations, thin product pipelines and the lack of new blockbuster drugs will restrain industry growth. Public sector cost-containment strategies (including the current changes to the PBS) and the increasing levels of generic competition will also constrain industry growth. The industry may also be affected by continued concerns about drug safety in the wake of the controversy surrounding various healthcare products, including those manufactured by Johnson & Johnson.

Over the five years through 2015-16 the industry will have to continue to adapt to the changing environment and increased risks it currently faces, including regulatory, product development and reputation risks. This will result in the re-evaluation of corporate strategies, the continued transformation of current cost end-efficiency models and the adoption of new business models (including an increasing reliance on contract manufacturing organisations and contract research organisations) as industry participants seek to become leaner and more efficient.

There will be greater use of new technologies and a rationalisation of product portfolios (including the disposal of non-core businesses) as companies adapt to the new realities of the global health market, and in some instances reinvent themselves. The industry will also focus on the development of hyper-specific or boutique drugs (as opposed to blockbuster drugs) and products targeting unmet medical needs in an attempt to maintain the strong revenue growth it has historically enjoyed. Drugs will therefore be targeted at considerably small population groups and will include high-tech, specialist-driven, low-volume medicines. Therefore, pharmaceutical manufacturers may become increasingly specialised as they adopt new strategies based on particular diseases relating to specific systems in the human body or targeted populations. Bolt-on acquisitions may become more frequent as players attempt to fill gaps in their pipeline, access new technology platforms (including biotechnology) or expand into new geographic markets.

Growth and regulation

Overall industry growth is expected to be modest, averaging 2.6% per annum to reach $10.66 billion by 2015-16. However, while the industry is expected to enjoy a moderate growth path, the path itself is expected to be significantly different from that of earlier times. In the near term, the ongoing changes to the PBS will restrain growth and squeeze margins, as may any further moves by multinational enterprises to cut local production capacity.

Employment levels are expected to decline marginally over the next five years, in line with the rationalisation process occurring in the global pharmaceutical market. At the same time, losses in the manufacturing industry may be partly offset by increased employment in the R&D segment. By 2015-16, industry employment is expected to be 13,250 compared with 14,240 one decade earlier.

As in the past, the regulatory nature of the industry will influence the underlying framework for the industry’s overall growth profile. The PBS will continue to dominate the scene, in particular the ongoing changes as it moves toward a system of price disclosure and full industry transparency.

In the near term, concerns may exist as to the validity of the historic Memorandum of Understanding (MoU) which had been signed in May 2010 (and re-signed in September of the same year) in the wake of the controversy surrounding the government’s decision in February 2011 to disallow any new products onto the PBS until 2013, when its budget deficit is once more under control. It is possible that this move will delay the approval of up to 100 medicines each year at a cost to the industry, which in turn arguing that the government should reverse this decision. The argument is partly based on the premise that growth in PBS expenditure appears to be under control, with growth levels currently at their lowest levels in 15 years. Moreover the Commonwealth Treasury is currently forecasting that PBS expenditure will grow at a rate of just 2.1% per annum (in real terms) over the next four years, which will again have implications for pharmaceutical manufacturers.

On the regulatory front, also of interest will be the fate of the Patent Amendment (Human Genes and Biological Materials) Bill 2010 that is seeking to amend the Patents Act 1990 to exclude biological materials. It may thus have fundamental ramifications for Australia’s biotechnology and pharmaceutical industries, with the latter arguing that biological medicines represent the cutting edge of medicine and that any moves to ban patents on biological materials will essentially stall medical research among other variables. 

More consolidation

While the global pharmaceutical manufacturing industry will grow moderately over the five years through 2015-16, further consolidation and rationalisation is likely given the globalised nature of the major industry players and their need to reduce duplication costs and achieve economies of scale.

It is also expected that there will be a number of acquisitions in order to acquire scale within a particular field (such as generics) or a particular product or technology. For example, pharmaceutical manufacturers may continue to look to highly specialised biotech firms as a means of broadening or expanding their R&D capacities, particularly as the lines between traditional-branded drug companies and biotechs becomes increasingly blurred. Other players may view acquisitions as a means of hole-filling, with an emphasis placed on bolt-on acquisitions. Thin pipelines may also prove to be one important impetus for various acquisitions. It is thus expected that several of the big pharma players will seek to acquire small to medium-size biotechnology companies.

Further industry consolidation may also occur as the larger global pharma players are forced to review their business models. With the new operating environment demanding capital efficiency, this may result in additional plant closures as companies outsource drug production to contract manufacturing organisations.

Larger players may also either divest their brand tail or limit their activities to certain targeted therapeutic groups, as they attempt to streamline their operations and improve both operating efficiencies and long-term profitability. Such moves are expected to continue in the near term. This will have a number of implications for the industry. The Minister for Innovation, Industry, Science and Research recently stated that the global pharmaceuticals industry is undergoing rationalisation that will affect the sustainability of the Australian industry. For example, the possible further closure of local pharmaceutical plants by multinational giants may inflict a severe blow to the domestic industry. On the other hand, these developments may provide opportunities for established local pharmaceutical manufacturers, particularly those involved in contract manufacturing. They may also provide opportunities for smaller firms as the larger players discard drug lines with lower profitability.

Rise of generics

In the near term, the patents of a number of key innovator drugs will expire. This will have implications for the industry, particularly for those players that are highly dependent on such products. According to IMS Health, products with sales in excess of US$80 billion in the major developed markets are expected to lose patent protection in the two years through 2012. Closer to home, Sigma believes that more than $2.5 billion of the current PBS spend is due to come off patent from 2010 through 2014.

Such a large number of patent expirations will present generic manufacturers with a historic opportunity for growth. Another implication of this development will be intensifying competition between brand-name pharmaceutical manufacturers and their generic counterparts. There will also be competition between generic manufacturers themselves, particularly if new operators enter this product segment, which is estimated to have low entry barriers. In response to this development, some companies are expected to extend the life cycle of their original drug through follow-on products, while others may jump on the generic drug bandwagon.

Generics currently account for about 14% of the total Australian pharmaceutical market and further growth in this market is anticipated. According to Sigma, generics will account for 17% of the market by 2012. This growth will also be aided by government policies, including the current PBS changes, designed to alter prescription patterns in favour of cheaper, bio-equivalent, generic drugs.

Other factors that will help change the industry over the next five years include developments in technology, including the increasing use of the internet and e-commerce (particularly for the dissemination of information on major branded pharmaceuticals). Continued falls in exclusivity times combined with an increased rollout of second- and third-generation products because of technological advancements will also occur. During the five years through 2015-16 there will also be a growing reliance on new technologies, such as genomics, which is hoped to accelerate research and reduce development times in bringing new drugs to the market. Biotech products will also increase in importance, while nanotechnology may also come to the fore as industry players look to nano-engineered reformulations of various key products due to come off patent over the next five years. At the same time, converging technologies will mean the lines between nanotechnology and biologics become increasingly blurred.

Key success factors

• Economies of scale: An adequate scale of production is important if the drug is listed on the Pharmaceuticals Benefits Scheme.
• Establishment of brand names: An established brand name is important, as the perceived risk in taking pharmaceuticals is lessened with identifiable brand names.
• Having technology sharing arrangements with major players: Collaborative arrangements, particularly in the research and development (R&D) area, help to spread the risk over a wider base and increase the probability of product innovation.
• Undertaking technical research and development: The ability to undertake local research and development not only helps with product innovation, but is also a prerequisite for entry into the Factor (f) scheme.
• Ability to alter goods and services produced in favour of market conditions: The development of new pharmaceuticals may increase revenue and market share.
• Superior financial management and debt management: Superior financial management and debt management is required due to the high cost of R&D as well as manufacturing and marketing the product.