India’s huge potential pharmaceutical market and wealth of industry talent means it will be strategically critical for multinationals in the years ahead, notes Rajiv Gulati, director of India-China strategy and corporate strategic planning for Eli Lilly. But weak intellectual property protection continues to hold the country back by hampering innovation, he says. In China, there may be even greater potential, but huge regulatory barriers block a clear path. Gulati spoke with India Knowledge at Wharton about these and other industry issues during the 2008 Wharton India Economic Forum.

An edited transcript of the conversation follows:

Knowledge at Wharton: What was behind Eli Lilly’s joint venture with Ranbaxy in the 1990s? I understand that you joined Eli Lilly from Ranbaxy at that time, when the companies formed this joint venture. What was the basis for that?

Gulati: Let me talk from Lilly’s side, because that was your question. For a long time, Lilly had been a Midwest-based, conservative pharmaceutical company, and the U.S. was [its] biggest market. So it used to [an] all-U.S. business, which was much smaller.

I would say the culture of the company changed when the new chairman, Randy Tobias, joined from AT&T [as] head of international business. He believed that there was growth outside of the U.S. That was a time when Lilly started operating in China, Indonesia, India, Bangladesh, Sri Lanka and many countries in Asia where it was never present.

When Lilly was starting in India, India had just begun liberalizing and the business environment was tough. It’s a difficult market, too — the distribution, for example. There are 271 cities with more than 100,000 in population. How do you reach that?

To go in as a new company and set up distribution, get all the regulatory approvals, [address] the manufacturing needs which were there at the time — it [wasn’t] easy. That’s where the partnership with Ranbaxy made sense. Ranbaxy was at that time the largest Indian company operating in India. That’s why the partnership came about, which really facilitated Lilly’s entry into the Indian market.

Knowledge at Wharton: Now companies like Ranbaxy and Dr. Reddy’s are challenging drugs that are going off patent. How is a company like Eli Lilly protecting itself from that trend?

Gulati: These challenges have been there and will be there. You protect yourself legally. The question is not how much multinationals like Lilly protect themselves. I think there’s a very strange question that Indian companies are struggling with. On one side, the patents have been reintroduced to India, and all large Indian companies want to become innovate pharmaceutical companies with their own patents.

On the other side, they have this huge generic business which is profitable, which is global. That’s where they are fighting lawsuits with the multinationals for the patents to go off so they can sell their generics. Now how do they make a transition from a very large generic company to becoming innovative? I think that that’s a challenge they are facing. Multinationals will have these challenges. It’s a given, because patents have a limited life. When the patents are challenged, there is a six-month exclusivity. That’s where generics make most of the profit, because after that it’s a commodity where the profit is much less.

So that’s a business model that all generic companies have worldwide. In fact, there’s a company in the US, and one year I think it made more profit from out-of-court settlements than by selling generics. So that’s a business model that was operating in the US for a long time and now Indian companies are following the same one.

Knowledge at Wharton: What would you say are primary deterrents of innovation? Or maybe the primary hurdles for innovation for the pharmaceutical industry in India?

Gulati: Everybody talks about intellectual property protection. Intellectual property protection is an award for innovation. If you don’t have adequate protection, it does not reward innovation, and it hampers innovation. And that’s what, on behalf of Lilly and other companies, even as an Indian I have been talking to the Indian government, that you cannot have research and investment in research within the country unless you have adequate safeguards to protect intellectual property.

Knowledge at Wharton: Now how does Eli Lilly’s strategy for China differ from its strategy for India?

Gulati: China is one of the fastest growing pharmaceutical markets in the world. It’s already moved from the 12th largest to being 8th or 9th largest. In the next five years it will be the 5th largest, and by 2020 or 2025, this will be the second largest pharmaceutical market in the world, overtaking Japan. And just second to the US.

Such a large and attractive market demands investment — a comprehensive presence. Please remember that in China, it’s centralized. Even the courts report to the government. At one time the pharmaceutical factories in China used to report to the FDA-equivalent in China, which is a very strange situation.

Therefore when you are dealing with the government, you are working with them and they want comprehensive presence too. So all your regulatory approvals, your pricing situation, your intellectual property, they are all linked with one central power. So you work with that authority for sales, marketing, investment in manufacturing, investment in R&D. It’s all linked and part of one large business process to have a comprehensive presence in a large market.

Whereas in India, the local industries are extremely strong because of a lack of patents for the last 35 years or more. And in that market, to compete even today at low prices and very high volumes is not a model which multinationals have perfected yet.

Therefore India has much more to offer because of their local industry strength and highly educated scientific pool of talent as a source for conducting clinical trials, for conducting discovery research, I would say for formulation development, chemical research, and so on.

So I would say India is far more important and can add far more value by outsourcing research and other services to that country, whereas China has much more value as a market, and that demands comprehensive presence. You need to look at these two significantly differently.

Knowledge at Wharton: What significant trends do you see on the horizon for the pharmaceutical industry?

Gulati: The pharmaceutical industry worldwide has a huge challenge, all of us know that. Large patents are expiring. And if you look at the quantum, we are talking something like US$50-US$100 billion worth of patents expiring in three or four years.
Remember, this is a US$600 billion industry worldwide. So 1/6 of the global sales, or more importantly 1/4 of the US sales for large pharmaceutical companies, will vanish in the next three to four years. That’s one challenge.

A second challenge is the rising cost of health care, which most developed countries can’t afford. In the US we have 15-16% of GDP being spent on healthcare. In Europe, in Australia, in Canada, the government pays for healthcare and they are broke too.
All across the developed world, Japan, Europe, even the US, the population is aging. And aging population means less productive people contributing to the pool and more people using the healthcare services, which insurance companies or the government have to pay for. Which means that [there will be] some kind of a control on costs, which will include pharmaceutical industry, either the pressure on prices or in Europe it’s very difficult to get new products on the formulary which the government reimburses.

So you have government pressures, you have challenges of patents expiring, and the third thing is the FDA, because of the recent happenings, has become very, very strict in approving new molecules. If you look at the trend, the [number of] new molecules approved by the FDA every year has been falling.

So you have patents going off, you cannot replace these with new products, and you have pressures of costs and formulary access worldwide. This is a challenge all multinationals are facing, and it’s a very, very difficult time for the industry.

Knowledge at Wharton: As a global industry evolves, do you think the differences between these markets are going to disappear?

Gulati: Just to give you a small number, in the US today 70% of prescriptions are generics. So by volume, that’s already a very large market. And those models have been operating always. It’s 30% of prescriptions are patented, which is why most of the value – because the price difference is huge – is under a huge threat going forward.

Knowledge at Wharton: Right. And do you think it’s still going to be an issue going forward reaching the population in India? You originally said there was actually an issue with accessing that population, getting the drugs out to them.

Gulati: It is. It is. And in fact most of the presentations that you are seeing today show that 60-70% of the population in India does not have access to medicines or to physicians. So that’s a huge challenge. India is the 13th largest pharmaceutical market by value, and 4th largest by volume. It has the lowest prices in the world and the latest medicines in the world available at those low prices. And yet, more than 60% of the population does not have access to medicines. That’s something we’ve got to change. I think all the industry, everybody has to look at it completely differently if that has to change, and access to medicine has to change.

Knowledge at Wharton: What kind of moves are companies like Eli Lilly making towards changing that?

Gulati: Eli Lilly is working on specific therapeutic areas as far as that is concerned. And I would single out diabetes. Lilly was the first company in the world, in 1923, to launch insulin, discovered by Dr. Banting and Dr. Best. And India and China, between them, have the highest number of diabetics in the world. Making localized insulin available, that’s one thing. But it’s more about the awareness, education, and the diagnosis of diabetes. And you cannot treat diabetes only by insulin. Insulin, in fact, is a drug of last resort. You start by diet, by exercise, then you go on to the oral tablets and so on.

And that’s an area where Lilly is making significant efforts in both the countries, India and China, to raise the awareness level, the education level, and making sure that you are diagnosed early, and you are able to take care of it so that you don’t even need insulin. Or maybe you can delay using medicines for a while.

Knowledge at Wharton: Right. Well, thanks very much for speaking with us today.

Gulati: It’s a pleasure to be here. Thank you.