Indian market context
API as a sector has been a neglected space within the Indian pharma, with India’s share of imports from China increasing consistently from ~60% in 2012 to currently ~67% in 2020. Understandably, the pandemic was a rude shock for most of the formulation players in early March with impending supply chain disruptions, given the overreliance on one country for many critical APIs and intermediates. While thankfully no major supply disruption happened last year, reliability of the supply chain needs to be safeguarded going forward, to be prepared for future shocks, including those that may be geopolitical in nature.
In this context, building a globally competitive and self-reliant API industry is the need of the hour. Unfortunately, we have only 3 Indian companies that have > 1 Bn $ valuation in this space, whereas China has over 77 companies already.
The government has come up with a policy response but like many policy responses, the incentives are not going to be enough to help achieve this vision. In our view, the answer lies in being able to unleash the Indian entrepreneurial creativity and deep chemistry skills, coupled with the favorable tailwinds globally to drive creation of unicorns in India.
Eroding advantage driving “Shift-away from China”?
Over the last few years, global markets have observed a shift away from the Chinese supply driven by three critical factors – reducing cost advantage, increasing regulatory challenges and degrading supply reliability. These issues have further aggravated by the ongoing pandemic eroding China’s global competitive advantage.
The foundation offering from Chinese companies is the cost advantage. With increasing labor costs driven by standard of living and focused efforts from the government to revise select incentive structures, including taxes, is resulting in loss of cost advantage when compared to a low-cost, stable market such as India.
Over the last 5 years, Chinese API companies have faced tightened, more frequent scrutiny from the regulators and warning letters have increased >2x compared to 2015. Customers have raised serious concerns with the quality issues and are looking to diversify the risk.
While supplier reliability has not been the most critical factor for customers pre COVID, recent times have created an additional value offering due to supply reliability. As Chinese companies tackle the pandemic and tighten environmental laws, capacity constraint is proving to be a major drawback.
As customers move volume away from China, Indian API industry is rightly positioned across all three dimensions to win over China. We believe there are 5 key areas where Indian companies can create sustainable advantage as discussed below to seize this opportunity.
Setting up independent, scaled platform
For global competitiveness, it is of paramount importance to think of scale which is lacking among Indian players. A large share of API capacity is used by formulation players which is restricted to captive consumption and is not able to reap the benefit of joint scale with merchant supply. A spin-off for API entities as an independent business will drive value generation from a larger scale.
On the other hand, independent API players have not been able to achieve the required scale standalone. A relevant approach to achieve is to create a platform by rolling up complementary assets through aggressive M&A. As add-ons merge, the primary synergies are released from the common front-end organization driving higher sales.
Designing clear business strategy
A clear business strategy is required for companies to foster the platforms and not lose focus. There are three strategies available – leader in large scale, mature molecules; early entry in molecules or molecules requiring specific, niche technology expertise. Each position seeks varying capabilities ranging across robust chemistry, operational excellence, development speed, supply reliability and customer relationships. A focused strategy enables in streamlining the portfolio selection process and target development or acquisition of right capabilities in order to lead the market.