Will pharmaceutical firms survive global giants’ onslaught?

By Chung Hee-hyung

Korean pharmaceutical companies are feeling pressure from all sides.

Relying too much on selling cheap generic drugs instead of developing original ones, analysts say they lack competitiveness to take on global players.

The government, on its part, forced the languishing domestic drug makers to substantially cut prices earlier this year, further chipping away at their bottom lines.

To make matters worse, the recently signed Korea-US free trade agreement (FTA) contains several provisions heavily in favor of original patent holders - making it far more difficult to get the government’s approval to market generic pharmaceutical drugs.

All in all, the country’s pharmaceutical firms appear to be midway through a seismic shift in the market, not seen for a decade, and which might require an equally bold change in strategy.

However, before prescribing the right medicine, observers point out that it is necessary to diagnose how the drug companies became stuck in the present predicament in the first place.

Too small to survive

Although the country’s pharmaceutical sector has been overshadowed by such export powerhouses as the giant electronics or auto industries, Korea actually has a fairly large pharmaceutical market.

Last year, the U.S. Congressional Research Service (CSR) reported that Korea ranks among the world’s top 12 in the pharmaceutical market, with $8 billion in annual sales. Similarly, IMS Health, an industry consultant, reclassified Korea’s pharmaceutical sector as a “developed” market two years ago.

However, the market is severely fragmented, with close to 300 drug makers and 500 wholesalers competing against each other. Few have either the resources or product lineup to compete overseas. Instead they mostly fight over the $8 billion domestic pie. That pie may appear big enough on the surface, but it is certainly not large enough to accommodate 800 pharmaceutical firms and wholesalers.



As might be expected, Korea’s drug manufacturers are too small to effectively compete against their western counterparts in the global market. Even Dong-A Pharmaceutical, the country’s largest maker of drugs, recorded a paltry $800 million in sales last year. That pales in comparison to Pfizer, which spent $9.4 billion in research and development alone during the same period.

“Even the country’s largest pharmaceutical firms do not have the resources to develop original drugs competitively enough to survive against western pharmaceuticals,” said Bae Ki-dal, analsyst of Shinhan Investment & Securities. “They simply can’t afford the cost. As a result, when the companies do come up with original drugs, they have little appeal outside the domestic market.”

Most crucially, the competition is not over the quality of the drugs, which might actually stimulate companies to come up with better medicine than its rivals. Instead, virtually all drug makers are heavily dependent on marketing generic drugs.

Generic drugs are defined as medicine that have a different brand name from the original but are otherwise identical in chemical compound. In industry jargon, they are “bioequivalent” to branded drugs with similar dosage form, safety, quality, performance characteristics and intended use.

Once the chemical compound of a particular drug is known, every drug maker can make a copycat version of that medicine with nearly identical performance and characteristics. It is much easier than developing a new drug because there is no guarantee that the large investment would ever bear fruit.

In fact, less than two out of 1,000 chemical compounds chosen for development go all the way up to the last stage of clinical trials to eventually get government approval. The process is expensive and time-consuming; Forbes magazine reported in February that the average cost of successfully developing a drug for the top 12 global pharmaceuticals for the past 15 years ranged from $ 3.7 billion to $ 11.8 billion.

Addicted to generics

It is not surprising, then, that Korean pharmaceuticals are less than enthusiastic about doing their own research and development (R&D) but instead have chosen to rely on copying foreign brands and sell them as generic drugs. Moreover, the government is accused of having played a large part in this.

In 1998, in the midst of the Asian financial crisis, the government introduced a new “step” price system to encourage speedy development of generic medicines. It was part of the administration’s efforts to save the flagging pharmaceutical industry from economic depression.

Under the system, drug makers were assigned different price caps by the administration depending on how fast they had registered their generic product. The first to register its drug was permitted to market the product at 80 percent of the original, while the next five registers were able to sell their drugs at 68 percent. Anyone who came afterwards could only set their price at 61 percent of the branded original.

It was not surprising that companies were eager to be the first to register their versions, and they concentrated what meager R&D resources they had on developing generic drugs instead of making original ones. The government, for its part, made little effort to stem the tide.

“Any company who met minimal requirements was granted the government’s approval. It just needed to come up with its own generic drug as fast as it could,” noted a senior manager from one of the country’s major pharmaceuticals.

It also meant that a lot of companies, which should have fallen out of the market, survived. If they managed to develop a generic drug first, they were in effect sanctioned by the government to sell their drugs at a higher price than their competitors. Guaranteed a steady source of profit, they had little incentive to develop original drugs or improve the quality of existing ones. It had a debilitating effect on the drug industry’s competitiveness.

The step price system had an unintended side effect as well. Because any line of generic drugs that copied a particular original brand shared the same chemical compound, they were virtually identical in quality and performance characteristics. With little way to distinguish themselves in quality, companies gave large incentives or “rebates” as they came to be universally known, to physicians or hospitals who agreed to prescribe or purchase their products.

It became a matter of course for drug makers to give their customers large discounts in advance or entertain them with expensive meals or lavish parties. Some companies even sponsored “seminars” in which participants were treated to sumptuous feasts or rounds of golf after they had attended perfunctory academic conferences.

The practice of providing rebates had a very negative effect on the drug industry. It was considered the major cause of high drug prices, and the Fair Trade Commission (FTC) estimated last year that the sum total of rebates amounted to $3 billion a year, with some companies reportedly spending nearly half their annual revenues on rebates alone.

The Ministry Of Health and Welfare (MOHW) vowed to crack down on such illegal practices. It even introduced a “double penalty system” in which both drug makers offering bribes and the physicians accepting them would be liable to punishment by law.

As with any assurances to root out systemic corruption, the ministry’s promise proved elusive. Companies were content to rely on generic drugs as their main source of income, and the ubiquitous practice of giving rebates showed little sign of abating. “I cannot say that the practice has disappeared entirely,” admitted Lim Chae-min, minister of MOWH at an annual auditing session at the National Assembly last year.

Changed circumstances

It looks as if a series of recent government policies and outside pressures are at last forcing the pharmaceuticals to change their problematic business models.

Realizing that the threat of punishment alone would not work, the MOHW resorted to the drastic measure of mandating companies to lower prices. In the ministry’s comprehensive plan “to cut medicine prices and enhance competitiveness of the pharmaceutical industry,” the government set a compulsory 17 percent reduction in drug prices for all drug makers.

The highly criticized “step” price system was also abolished, and companies were no longer afforded the privilege of setting a higher price according to how quickly they registered their generic product. Instead, all generic drugs had to be sold at a flat price of 53.5 percent of the original, although companies were free to sell them at a lower level. The plan took effect from April, and companies grudgingly accepted the newly imposed regulation.

The result showed in the statistics. Although the numbers on second quarter earnings has yet to be released, analysts widely expect that the recently enacted policy would take a large share out of the pharmaceuticals’ profit.

“The government’s regulation in April is expected to bring stock prices of major pharmaceuticals to their lowest point in the second two quarters of this year,” said Bae of Shinhan Investment & Securities.

“Most companies have seen more than 20 percent reduction in their profits, and although the situation is unlikely to get worse, it will take some time before their stock returns to previous levels.”

The recently enacted Korea-U.S FTA, moreover, may have a bigger impact on the country’s already beleaguered pharmaceutical sector. The agreement, which came into effect in March, is packed with several provisions strongly protecting intellectual property rights.

The “patent-linkage” clause, in particular, mandates the Korean government to notify the original developer whenever a drug maker seeks approval for its generic version. If the patent holder makes an objection and the government finds that the claimed patent does exist, it is obliged to deny market approval.

The pharmaceutical, on its part, is required to give detailed “safety and efficacy information” to the authorities to make sure that its generic version of the original medicine makes no infringement of intellectual property rights.

Because almost all of Korea’s generic drugs are copied from originals initially developed by Western pharmaceuticals, the days when Korea’s drug makers could easily make profits from generic drugs may be numbered.

“Previously, the government was free to give its stamp of approval even when the original patent was still valid,” said Yang Jung Suk of MOHW. “Pharmaceuticals, taking full advantage of this, applied for marketing approval at the earliest possible moment. In this way, they could go on selling the approved generic drugs right after the original patent expired.”

The FTA, however, changed much of this situation. “If a patent holder claims that the government has not followed appropriate procedures in granting its approval, the procedure might be delayed even after the patent has expired,” Yang noted.

“Even a ‘nominal’ patent, in which the original drug maker simply changes the drug’s gene sequence but nothing else, could hold up an approval for several months,” added Yang.

The clause could significantly restrict the movements of generic drug makers. “We are not even sure how much information we are supposed to give to the authorities when filling out our application,” complained a senior manager of a major pharmaceutical company at an information session held by the Korea Food and Drug Administration (KDFA) in May. “The FTA is silent on this, and we are in the dark as to how detailed such information should be.”

The pharmaceutical firms, in fact, may be equally in the dark as to how they should cope with the ever increasing threat from within and without. Maybe the drug makers are suffering from the side effects of their generic drugs, and they should overcome the addiction to their own products in the first place.