Russian pharma: from distribution to biotech

Trusted Judgements

Dr. Jan Dauman, CEO of CET-InterMatrix, a sector-specialist advisory and consultancy group

With imports prevailing over weak domestic production, distribution remains the dominant business

Russia's pharmaceutical sector has not followed the standard development path. Typically, the opening of a market to international products means that, among the three key players – producers, distributors, and retailers – the middlemen distributing relatively higher-quality imports begin as the strongest player. They gradually cede power to local producers, whose brands and products become important and recognizable, and to retailers, who gain in size and are able, by virtue of the volume in which they work, to cut deals directly with producers.

This has not yet happened in Russia, for the reason that domestic producers still have very low-end, usually generic, product lines, produced in small-scale volumes. Nizhpharm, purchased in 2004 by Germany's Stada, is an exception, with its good quality creams and ointments. Pharmstandard, despite a May 2007 IPO putting the company's value at $2.2bn, is the rule: it can boast only Arbidol (a Tamiflu analogue) among quality products.

The weakness of the domestic production sector can be traced back to resource-allocation decisions in the Soviet central-planning era, which concentrated R&D in pharmaceuticals in East European satellite states. A very interesting possible exception can be found in the alternative to chemical pharma, which is pharmaceutical applications developed from a biotechnology research base which has its origins in the Soviet biological warfare programme, for which no expense was spared and the best scientists allocated. For now, applied biotech offers the best prospects for the domestic production sector, even if no commercial applications have materialized as yet.

A market dominated by importers is not that exciting for them

Even if Russian producers were active in R&D (which, by and large, they are not), the drawn-out nature of R&D and the drug-pipeline means that patented imported drugs will dominate the Russian market for the foreseeable future. But importers are not always particularly aggressive. There are various factors at work here.

1. Inadequate government spending on drug procurement means that the market is smaller and growing less fast than would be expected, given Russia’s present national income and overall economic growth. So the Russian market is not a "life-changing" one for international pharmaceutical majors, in the sense of having a material marginal impact on their earnings performance. Partly because medicines have always been a low public spending priority (despite many promises to change this), and partly for cultural reasons: Russia is not a pill-popping nation, and Russians tend to prefer traditional methods and treatments or be (nihilistically) passive in the face of ill-health.

2. There are non-trivial costs involved in promoting drugs with regional sales teams and medical specialists who introduce drugs to physicians; Russia's geographical size piles on logistical costs to man-power costs.

3. Heightened vigilance (largely US-driven) related to the Foreign Corrupt Practices Act incentivizes drug companies to de-prioritize regions where tendering processes invite, or merely appear to invite, misbehaviour.

Nonetheless, watch for applied biotech and IPOs

In the meantime, as foreign imports continue to dominate, distributors with local knowledge who are able to move those products inter-regionally will continue to play their key role into the future. The 1998 crisis made proper professional businesses out of the distributors which survived, and they have grown sophisticated and specialized since then. (No such stimulating or disciplining force has come to bear on Russia's domestic pharmaceutical producers.)

Going forward, more consolidation will probably occur, although it is unlikely between producers and distributors, since distributors would not want to restrict their stable of products to those of a single producer, and producers would not wish their products to be offered alongside those of their rivals.

The more plausible consolidation is of distributors with retailers. Further deals are to be expected along the lines of Protek, the distribution market leader, establishing the Rigla pharmacy chain and of the recent acquisition of the Russian distributor Apteka Holding by Alliance Boots. But some of the distributors already have the scale and autonomy to make an IPO the more logical exit for founding entrepreneurs. This may apply in particular to Protek and possibly SIA, the other market leader.

Besides applied biotech and distributors, areas well-placed for growth are private hospitals and drugstore retail, which remain most exposed to the middle-class consumer boom.