Drug makers suffer an overdose of control

The new price caps for 191 essential drugs are likely to introduce serious distortions in the market for these medicines

The National Pharmaceutical Pricing Authority, or NPPA, has announced new price caps for 191 essential drugs that are 10 to 50 per cent lower than the current prices. Drug makers have 45 days to recall the earlier batches and send out new ones with the lower price tags. This is a part of the Drug Price Control Order, 2013, that aims to bring 348 essential drugs under price control, against 74 bulk drugs earlier. So, more price caps will be announced in the weeks to come. Companies that sell below the price caps cannot raise prices - they'll continue to sell at the old prices.

The switch, various estimates suggest, will raise the span of price control from 18 per cent of the market (currently worth Rs 72,000 crore per annum) to 30 per cent. AIOCD Pharmasofttech AWACS, a pharmaceutical market research company, has analysed 140 of the price caps fixed by the NPPA: the current maximum retail price of these drugs is Rs 3,633 crore; the price caps will cause value erosion of Rs 920 crore (this can also be seen as the gain to patients). Drug makers, it adds, will absorb 51 per cent of this burden, and the trade will shoulder the remaining 49 per cent. The Indian Pharmaceutical Alliance has said the profitability on the 348 drugs will fall from 12.5 per cent to 6.4 per cent.

Many see it as a political move by the United Progressive Alliance ahead of the 2014 elections. The observation is not without merit - it needs to be seen in conjunction with the proposal to provide free medicine through government hospitals and dispensaries at an annual cost of Rs 30,000 crore. Medicine forms an unusually high part of the expenditure incurred by poor households. For the poorest 20 per cent of Indians, according to the National Sample Survey, medicine alone accounts for 85 per cent of their total health care expenditure. A World Bank study says that out-of-pocket medical costs push 2.2 per cent of the population below the poverty line every year. So, inexpensive and free medicine holds great electoral promise.

Actually, medicine prices in India are among the lowest in the world - lower than even Bangladesh and Pakistan. That's because India is the most competitive market in the world with thousands and thousands of drug makers. From this point of view, a fresh crackdown on prices is uncalled for. The logic for price controls can also be questioned when the government has another potent weapon to make essential medicine available at low prices: compulsory licences. In fact, the government has already done that in the case of Bayer's anti-cancer drug, Nexavar, by authorising Natco Pharma to produce an inexpensive version. There could be more compulsory licences in the days to come.

That apart, price controls are justified if companies in the sector make super-normal profits. Numbers collated by the Business Standard Research Bureau show that in the last seven years, from 2006-07 to 2012-13, the net profit margin of pharmaceutical companies has outperformed that of Nifty-50 companies in three years; in the other four, it lagged behind (see table). There is also no trend visible if the profitability of the pharmaceutical sector is on the rise. Even the net profit margin of 11.87 per cent for 2012-13 is deceptive because the sector gets up to a third of its business from exports which have a credit line of 180 to 360 days; so, the cash profit does not work out to more than eight or nine per cent. This certainly does not look like super-normal profits.

On the other hand, price controls could introduce serious distortions into the market. For instance, it now makes sense for drug makers to pull out of categories that are under price control and focus on the other category. This could happen except in the case of companies that may find it difficult to let go of the brand equity of a product. It is also true that companies with low overheads will benefit from the price caps. So, aren't we rewarding those who invest as little as possible on research and processes? The earlier price controls, over 74 bulk drugs, controlled all combinations of these products. Now that formulations have been specified, a drug maker can escape price control by altering the combinations. The new Drug Price Control Order also specifies dosage forms for price control. What if a drug maker comes out with a new dosage?

To make matters more muddied, a controversy has broken out between the industry and the NPPA. The industry has alleged that the Union Cabinet, while approving the Drug Price Control Order, 2013, had said that the price caps will be an arithmetic average of all brands with one per cent market share or more; however, the NPPA has included all brands of a company while shortlisting such brands. Its logic is that these are essentially the same product and hence should be bunched together while looking at the market share. The industry says that a company's name is different from a brand. More important, it alleges, this has resulted in deeper cuts in prices. It was the industry that had pushed the government to shift from price control based on production costs to one on market prices. If a fight has still broken out, it only shows that we haven't heard the last on drug price caps.