Russia’s pharmaceutical sector is aberrant in several respects. Total pharmaceutical spending relative to GDP is well below the OECD average, as this has not been a government priority. As a result, private demand untypically accounts for the bulk of the drugs market. Despite being thus embedded into Russia's dynamic new retail sector, pharmaceuticals fail to ride the middle-class consumer boom, since much of the natural demand comes from older and poorer people with less purchasing power. So the importers who dominate the Russian market, given the weakness of domestic producers, do not treat this market as a top priority. The upshot – also unusual – is that distributors rule the roost and now include some attractive IPO candidates.
Scope for positive change lies in the lessons learned from the government's first serious attempt to boost pensioners' access to medicines (the "DLO" programme) and in the redeployment of Soviet-legacy strength in biotechnology to new drug discoveries.
When the centralized Soviet provision, such as it was, of healthcare and medicines collapsed, Russia's never-strong domestic pharmaceutical production shrank by a factor of five. Imported pharmaceuticals poured in, despite their relatively high cost, and pharmacy kiosks selling them appeared alongside state-controlled drug dispensaries. The loss of a centralized procurement process left regional and municipal authorities scrambling – increasingly in overpriced retail markets – to provide hospitals with drug stocks that in-patients were supposed to receive gratis.
As in every state sector, funding was systemically lacking, and failures by state authorities to pay drug producers was followed inevitably by short supplies, at least in the public sector. Federal and regional authorities compiled (wish) lists of "essential and life-saving" drugs and tried vainly to boost local production of the latter with tax exemptions. The financial crisis of 1998 dealt a withering blow to infant relationships between Russian distributors and big foreign pharmaceutical producers.
Gradual recovery has been under way for about a decade. According to the Federal Statistics Service, the percentage of household expenditure for "personal hygiene and medicine" jumped 1 percentage point from 1995 to 2000 (from 2.9 per cent to 3.9 per cent) and has remained steady since then. The implication is that pharmaceutical consumption growth tracks growth in real incomes, averaging about 11-13 per cent per year, which is roughly what the more sober industry-watchers estimate (see chart). To put the $11bn Russian pharmaceutical market into context, the world-leading US pharmaceutical market reached about $330bn in 2006, and Italy's is projected to reach $30bn in 2007.
*2002-2007 figures use actual Rb exchange rates, 2008-2012 figures use Rb25=US$1
The above chart shows a steady but (by the standards of much of today’s Russian economy) unexciting trend growth of around 10 per cent per year, with the apparent promise of the market’s 36 per cent annual jump from 2004-06 not being sustained. That surge was due to an anomalous boost the sector received from a government programme which is undergoing re-evaluation. Its impact is perhaps best revealed in a breakdown of sector sales (see chart) showing "federal and regional government sales" grew markedly with the 2005 injection of the DLO budget.
State provision of medicines for the poor is one of several areas of public welfare which the Putin administration has tried to improve. This story began in 2004 as part of a wider reform to replace various in-kind entitlements with monetary transfers. In the case of prescription medicines, the beneficiaries (mainly pensioners, together with some other deserving social groups) were given the alternative (to a monthly cash benefit) of eligibility to a free package of medicines defined in the "Provision of Supplementary Medicines" programme, known in Russia by the abbreviation "DLO" (for more detail, click here).
With its Rb50.8 billion first-year budget, the DLO immediately raised the international profile of the Russian pharmaceutical sector. In addition to putting real money behind spending commitments which had previously been largely unfunded, that budget – boosted by transfers from the government’s oil-related fiscal windfalls – also increased the total spend, as the DLO encouraged the take-up of more expensive drugs than were normally purchased in the commercial market. This gave a substantial boost to some importers' revenues. The $45,000 annual cost of insulin for a diabetes patient is a striking example: Russia's average annual income in July 2007 was about $6,070.
Unfortunately, this maiden attempt to boost Russian state support for health expenditures experienced growing pains. These included funding miscalculations (medicines prescribed in 2006 exceeded that year's budget by two-and-a-half times, reimbursements failed to cover supplier costs, shortages ensued) and bribery scandals related to the regional tender process.
While the government confirms that it will rework but not abandon the DLO (state procurement of drugs accounts for about 20 per cent of the market), market participants are generally discounting the DLO's place in their future strategies. For example, DLO sales represented 8 per cent of manufacturer Veropharm's sales in H1 2006, but just 4 per cent in H1 2007. PharmStandard's "strategy" page on its company website ranks exploiting opportunities presented by the DLO as sixth out of six strategy elements and states explicitly: "our growth strategy does not depend on government healthcare expenditure." The first half of 2007 saw the first drop in import growth since 1998 as many importers shifted their shipment mix away from higher-end drugs after the DLO had struck 600 such drugs from its list in November 2006.
Producers
Production remains very small in scale and imported pharmaceuticals (accounting for 70 per cent of the total volume) still prevail over domestically-produced, usually generic drugs. The hardiest local manufacturers persisted through the lean years and even occasionally invite takeovers from foreigners seeking a foot in the door of Russian pharma. Industry-watcher DSM Group has ranked domestic production (whether by indigenous or foreign companies) by the value of H1 2007 sales: leaders include French Sanofi-Aventis ($153.6m), Russian PharmStandard ($132.5m), Hungarian Gedeon Richter ($99.7m), Slovenian Lek DD ($91.8m) and US Pfizer ($89.5m). (For more detail on producers, click here)
Russian producers' revenues are modest in absolute terms, despite very fast growth. When the government has tried to boost domestic production, it has not had much success. For instance, the DLO was supposed to provide a 70:30 proportion of domestic to imported drugs, but the proportion is still only about 9 per cent domestic (DSM). In the case of a specific drug with consistent public and private sector demand, some 97 per cent of insulin on the Russian market is still imported, while much domestic production is working considerably below capacity (WebDigest).
Distributors
Another part of the pharmaceutical sector looks more promising: this is distribution. There are about seven major players in pharmaceutical distribution in Russia (see table below). These took the place of Soviet centralized procurement and serve as the missing link between retail and public-sector end-users, on the one hand, and the still overwhelmingly preferred foreign-imported pharmaceutical products, on the other. Essentially a specialist logistics and marketing mechanism, pharmaceutical distribution remains a scaleable and profitable business in its own right, and there is some movement towards linkage with retail drugstore chains.
Russian pharmaceutical distributors, ranked by sales relative to the sector leader
|
Distributor |
Relative gross sales volume (Q1 2007) |
|
Protek memo item: 2006 revenues $2.17bn* |
1.00 |
|
SIA International |
0.923 |
|
Katren |
0.386 |
|
Rosta |
0.378 |
|
Apteka Holding (Alliance-Boots) |
0.261 |
|
Biotek |
0.222 |
|
Moron |
0.220 |
|
Shreya |
0.147 |
* Kommersant, 27/08/07
Source: Pharmexpert
Pharmacies
Russia's fast-moving retail revolution quickly extended to modern drugstores, which have replaced the kiosks of the 1990s. Even though state-run dispensaries exist and indeed remain powerful players in some regions (e.g., Ulyanovsk, St. Petersburg), retail drug-store chains are now an element of Russia's overall retail story, selling not just medicines but the full range of "parapharmacy" items Western consumers would expect. There is growing integration between distributors and drugstore chains; examples include Protek's two chains (O-3 and Rigla), Alliance's Alphega drugstore project, Apteka Holding's Moya Lyubimaya Apteka chain and Rosta's chain Raduga. A less obvious but important link is the stake of retail-sector leader Apteka 36.6 in the well-run generics producer Veropharm.
There is also noticeable consolidation taking place within the sector, as drugstore chains build out into the regions and buy out rival chains and independent stores. Apteka 36.6 is also moving in this direction, having acquired eight regional chains in January 2007 and another 48-store chain in H2 2007.
Russian retail drugstore chains
|
Drugstore chain |
Company information |
Number of stores (Q1 2007) |
|
Apkteka 36.6 |
Company-reported: consolidated sales for H1 2007 totaled US$385m or 77 per cent y.o.y. growth. |
854 (company-reported: 936 stores, not including most recent acquisition of 48 additional stores from Zdravnik chain) |
|
Rigla |
Protek-affiliated |
504 |
|
Doctor Stoletov ("Dr. Hundredyears") |
Owned by Impexbank founder Boris Ivanishvili, who expanded Dr. Stoletov through the 2007 purchase of Ephedra (Saratov) with its 119 regional drugstores to create a drugstore group rivalling 36.6 and Rigla. |
375 (+ 119 = 494) |
|
Implozia |
Samara-based chain that has moved into Ufa by purchasing a local chain in that city |
371 |
|
Biotek Group |
Regional drugstore chain linked to a distribution network; owned by Penza rep to Federation Council, Boris Shpigel. |
350 |
|
Zdorovye Lyudi ("Healthy People") |
Owned by Renova Group, rebranded from Natur Produkt, a Moscow and St. Petersburg based chain |
188 |
|
0-3 |
Protek-affiliated |
146 |
|
Alphega |
Alliance Healthcare/Apteka Holding-affiliated; allowed to buy from other distributors, but benefiting from "considerable discounts from Alliance" |
50 stores planned by year-end |
Source: Pharmexpert, unless otherwise indicated.
Dr. Jan Dauman, CEO of CET-InterMatrix, a sector-specialist advisory and consultancy group
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.
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.
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.
The recent swell of enthusiasm for Russian pharma on the back of a single (somewhat ill-fated) government attempt to help the poor get medicines may have required a reality check: the actual market size is in fact quite small and production weak. Our trusted source stresses the government's own pharma spend, low by international standards, as the key brake on the entire sector's development. Cause for encouragement is the reworked DLO, which, with its 2007 budget boosted from Rb34.9bn to Rb68.2bn (US$2.5bn), seems to indicate the serious commitment the Russian government is at last prepared (and financially able) to make to pharmaceutical procurement. Is the DLO the "first swallow of the spring"? Russia's convergence to international norms predicts this outcome, but companies are probably wise to wait and watch for now.
Our trusted source flags two intriguing possibilities. The first is that Russia retains a comparative advantage left over from Soviet-era biotechnology. Some insight into the drug-pipeline potential of this area is available through the International Science and Technology Center (ISTC), established by international agreement in 1992 as a nonproliferation programme, and now a coordinator of "the exceptional pool of scientific talent available in Russian and CIS institutes" working on originally-military projects like anti-anthrax or anti-tumour drugs (for more information, click here).
The second point is the IPOs which are likely to come. Distributors Protek and SIA International are plausible IPO candidates in the next 18 months, with the latter possibly also in the sights of majority owners of PharmStandard, whose May 2007 IPO had a very positive outcome.
Another possible candidate for an IPO is Russia's second-largest domestic producer, Otechestvennye Lekarstva, whose executive director is an alumnus of Nizhpharm (the producer singled out for praise by our trusted source) and which runs an annual competition to attract institutional researchers with ideas to translate into sellable pharmaceutical products. This effort to draw upon home-grown R&D highlights the present backwardness of the sector – but also its genuine potential.
Name |
Description |
|---|---|
|
About a sixth the size of the market leaders, distributor Shreya 9an arm of the above traded company) focuses on commercial and hospital sales. | |
|
Not listed. About a quarter of the size of leading Russian distributors. | |
|
Not listed. Biotek is a major distributor and regional drugstore owner. | |
|
Apteka Holding, a non-listed company, sold a 96 per cent stake to Alliance Unichem in February 2006 in a deal reportedly worth US$34mn. | |
|
Not listed. With Katren, about a third the size of biggest distributors. Sales based on commerical market and DLO. | |
|
Not listed. Drug distributor one-third the size of sector leaders. | |
|
Not listed. One of Russia's biggest distributors (other being SIA International), 2006 revenues estimated at US$2.17 bn. | |
|
Not listed. One of two highest-valued Russian pharma distributors (the other being Protek). Value estimated at US$2bn. | |
|
Not listed. Russian manufacturer of over 150 types of drugs | |
|
Not listed. Major Russian drug manufacturer | |
|
Russian drug manufacturer connected to major drugstore chain 36.6 | |
|
UK based importer of drugs to Russia | |
|
German producer with acquired facilities (Nizhpharm, Hemopharm, MAKIZ, Skopinpharm, Biodyne) in Russia | |
|
Slovenian manufacturer with production facilities in Moscow | |
|
American importer of drugs | |
|
De-listed. Slovenian importer of a range of drugs | |
|
Not listed. German-Italian company that imports a range of drugs. | |
|
Biggest producer of Russia-consumed drugs; latter include: vaccines, cardiovascular drugs, OTC, and generics. | |
|
Russia's largest drugstore chain | |
|
Hungary-based drug manufacturer with best-selling pharmaceuticals in Russia | |
|
Pharmstandard, the largest Russian pharmaceuticals producer in Russia was valued, after its 5/07 IPO at $2.2 bn. Pharmstandard manufactures drugs in five facilities in Russia, and includes in its product-line Arbidol, a Tamiflu substitute. Core owners are Viktor Kharitonin, Yegor Kulkov and Millhouse Capital, the investment vehicle of Russia's richest man Roman Abramovich. | |
|
Not listed. French drug importer with best-selling pharmaceuticals in Russian market |
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