Survey of the Pharmaceutical Industry in Russia

2010

Introduction
It has become traditional for Ernst & Young to prepare regular surveys of various sectors of Russian industry. This year we have for the first time conducted a survey of the pharmaceutical industry in Russia. At a business dinner held in January 2010 Ernst & Young employees discussed the situation in the industry with 25 senior executives of major foreign pharmaceutical companies operating in Russia. The event occurred just as industry reforms were beginning, and market leaders expressed concerns as to what measures the Government would take and how the market would operate under the new conditions. This survey covers a period of active reform of the industry by the state. Measures taken by the Russian Government in recent times with a view to developing pharmaceutical production within the country and strengthening the competitive position of domestic companies have provoked much debate and dispute. This report uses the results of the survey to show how representatives of various companies view the current trends in the development of the industry, outlines key legislative changes and their significance and examines the growth potential of the pharmaceutical market. We would like to thank all participants in the survey who shared their opinions with us, and look forward to future co-operation.

Survey of the Pharmaceutical Industry in Russia, 2010

Contents
Main conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Brief economic overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Reform of the pharmaceutical industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Factors affecting the development of the industry in 2010 . . . . . . . . . . . . . . . .14 Analysis of market development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16 Participants in the survey . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Contact information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21

Survey of the Pharmaceutical Industry in Russia, 2010

Main conclusions
The comments made to us in January 2010 indicated that representatives of pharmaceutical companies were in a state of confusion. The determination on the part of the state to change the rules of play, the rapidity with which those changes were being implemented and the scale of the changes led company directors to express uncertainty as to the prospects for development and as to whether the changes had been properly thought out. Now that 2010 has passed, the participants in our survey indicate a definite imbalance between the prospects for the development of the Russian pharmaceutical market (which were rated fairly high) and the level of transparency of the existing legislative regulatory framework (Figure 1). Generally speaking, Russian manufacturers rate the clarity of current legislation higher than foreign importers. They have a clearer understanding of the recently proposed changes in the regulation of the pharmaceutical industry. The results of the survey indicate that Russian manufacturers take a slightly more optimistic view of the situation than foreign importers. In 6% of cases Russian manufacturers show greater confidence in the prospects of the Russian pharmaceutical market, which is undoubtedly a consequence of the states import substitution policy. Nevertheless, a number of analysts believe that Russia is still attractive to investment by foreign companies thanks to high profit margins, the potential for market growth and prospects for market consolidation, despite the slower pace of development compared with other BRIC countries. vital and essential medicinal products (formerly the list of vital and essential medicinal drugs), including the procedure for determining and registering maximum manufacturer supply prices and new maximum wholesale and maximum retail mark-ups for sales of such products The importation of medicinal products into the territory of the Russian Federation Procedures for the conduct of pre-clinical, clinical, international multicentre clinical and post-registration clinical research The manufacture and marking of medicinal drugs Market participants are already noting the impact of the changes on the results of their activities, but the effect so far is minimal: difficulties in registering products and prices, local changes in prices and sales volumes and the review of relationships between participants. The current difficulties are largely attributable to the rapid pace and deficiencies in the planning of the reforms, and have not yet caused changes in the market shares of the 15 key market participants. However, general forecasts made by the respondents suggest that the geography of the market may change as a result of the nascent localization of the manufacturing of imported goods, the redistribution of the market shares of key players as a result of the reform of the compulsory medical insurance system and the growth in the market shares of Russian companies by virtue of the state support available to them. It is quite possible that major structural changes in the market will in fact occur in 2011. These would be the result of substantial reforms in the state regulation of the sector in 2010 and further legislative changes which may shape the future structure of the market.

2010: the beginning of changes

2010 was a momentous year in the history of the industry, as it was the year in which most of the reforms undertaken by the state took effect. The reforms affected the entire sphere of circulation of medicinal drugs, including: The procedure for the registration/ re-registration of medicinal products The rules for the regulation of prices for medicinal products included in the list of

Figure 1. Rating of prospects for market development and clarity of legislation

Rate your level of condence in the prospects for the Russian pharmaceutical market on a scale of 1 to 5 (where 1 - low level and 5 - high level) Rate the level of clarity of legislative / regulatory acts governing the Russian market and the transparency of regulatory bodies on a scale of 1 to 5 (where 1 - low level and 5 - high level) Rate how far you understand the recently proposed changes in the regulation of the pharmaceutical industry on a scale of 1 to 5 (where 1 - do not understand them and 5 -fully understand them) 1 2 3

3,7 3,6 3,8 2,2 2,1 2,3 3,3 3,1 3,5

4 5

All Foreign manufacturers / importers Russian manufacturers

Survey of the Pharmaceutical Industry in Russia, 2010

Pricing
The respondents point to a generally unfavourable legislative background as the factor which most impacts their activities and give a negative assessment of initiatives to strengthen price regulation, believing that they are ineffective and need to be revised. Over a half of companies have seen profit margins fall under the new conditions (foreign companies have felt this more acutely), but this is in keeping with the objectives of the legislative measures aimed at price regulation. The survey data show that 95% of all manufacturers managed to register maximum supply prices for all products in the list of vital and essential medicinal products, excluding the 17% of Russian manufacturers who were unable to reach agreement with supervisory authorities on a number of items. In this respect, 29% of foreign manufacturers / importers lowered the prices for some items relative to the prices stated in their applications (as opposed to 17% of Russian manufacturers).

Despite the negative assessment of the changes, many participants in the business dinner organized by Ernst & Young at the beginning of 2010 acknowledged that pricing on the pharmaceutical market is a prerogative of state policy. They asserted that the time has now come to apply the experience of European countries in the area of price regulation.

Reaction to the changes

Market participants and experts have expressed the view that the state has implemented the changes too quickly and without due regard to the opinion of the business community, and that it failed to grant representatives of the business world the opportunity to influence the reform process. In this respect, Russian and foreign companies have different reactions to the changes. Russian companies are negotiating with state bodies and considering ways of adapting marketing and commercial strategies. Foreign enterprises, meanwhile, are preparing for more extensive changes in the model for doing business in Russia, as well as carrying out changes in their commercial, production and distribution operations.

In our view, the differing opinions expressed by the respondents indicate that the companies have not yet been able to form clear new strategies in the context of the adoption of the new rules governing state regulation of the market. The effects which the respondents expect to see include a cardinal redistribution of market shares among the principal players (primarily in quantitative terms), a growth in the market share of Russian manufacturers, the ending of supplies of certain medicinal products to Russia and the need to change elements of their business model.

Survey of the Pharmaceutical Industry in Russia, 2010

Brief economic overview

State of the pharmaceutical market in 2010 and growth forecasts
According to data compiled by industry experts, the total volume of the medicinal products market in 2010 was around 17.7 billion dollars (based on end consumer prices), which is 13% higher than in 2009 (8% when expressed in rouble equivalents). The market volume in quantitative terms increased by 9% (the highest growth figure since 2005). Forecasts made by CMI Pharmexpert suggest that in 2011 the market for the consumption of medicinal drugs in Russia will grow by a best-case 15% and a worstcase 8%. The rate of growth of the Russian market, which is ahead of the global market growth rate (5-7%), will remain steady over the next few years. In 2010, like the year before, imported products made up a large part of the overall volume of consumption, accounting for around 66% in monetary terms. It is anticipated that in the next few years the proportion of imports will gradually decrease: according to a federal specialpurpose programme it is planned that the proportion of imported medicinal drugs should be reduced to 50% of overall consumption by 2020. According to data issued by the Ministry of Economic Development, by 2013 the quantity of medicinal drugs manufactured in the Russian Federation should almost double relative to 2009. A number of analysts believe that the Russian pharmaceutical sector is at present showing greater profitability than developing markets, and particularly India and China. However, Russia will lag behind other BRIC countries in the terms of the pace of growth in the next few years owing to its declining population and lower per capita consumption of pharmaceutical products.

Brief overview of the health care sphere

Total state expenditure on health care in 2010 amounted to 675.59 billion roubles, which is 0.7% lower than the previous year. In this respect, the share of regional budgets in that expenditure rose considerably in 2010. Health care expenditure in 2010 accounts for 3.6% of GDP. The Russian Government has said that by 2013 health care expenditure will grow by 40% and will be close to 5% of GDP.

Figure 2. Volume of pharmaceutical market in monetary terms: optimistic forecast

1000 900 800 700 bln. Rub. 600 500 400 300 200 100 0 2008A 2009A 2010A 2011E 2012E 2013E 2014E
*CAGR Compound annual growth rate, A Actual, F Forecast Source: CMI Pharmexpert, analysis by Ernst & Young.

CAGR 13% 706 619 495 310 538

893 797

Survey of the Pharmaceutical Industry in Russia, 2010

Table 1 . State health care expenditure (billion roubles), 2009-2010

Indicator Federal budget Consolidated budgets of constituent entities of the Russian Federation 2010 450.13 2009 434.04 Budgets of territorial state funds 2010 24.07 2009 26.75 Total

2010 Health care expenditure, total * Health care expenditure as a proportion of total state expenditure (%) 201,40

2009 219.84

2010 675.59

2009 680.3

2.42

2.69

8.21

8.42

4.66

5.43

4.72

4.92

* Excluding expenditure on fitness and sports; applied and scientific research in the field of health care, fitness and sports; other matters pertaining to health care, fitness and sports. Source: Federal Treasury of the Russian Federation.

In 2011, 134.9 billion roubles will be allocated to the high-priority Zdorovye national project (6% more than in 2010); 49.3 billion roubles will be allocated for the

purchase of expensive medicinal products under the Seven High-Cost Nosologies programme (11% more than in 2010); 41.3 billion roubles will be allocated for the

purchase of medicinal products under the programme for the supply of essential medicinal drugs (ONLS).

Table 2 . Volumes of financing under the Zdorovye project

2010 (Law No. 308-FZ) Volume (billion roubles) Change relative to preceding year: billion roubles %
Source: Ministry of Economic Development of the Russian Federation.

Revised budget spending report as at September 1, 2010 126.9

Calculated volumes of financing 2011 (draft) 134.9 +8.0 +6.3 2012 (draft) 139.5 +4.6 +3.4 2013 (draft) 100.5 -39.0 -28.0

126.9

In 2011 it is planned to increase the per capita level of financial support for concession recipients to 952 roubles per person, which is 26% higher than in the preceding year according to information from the Ministry of Health and Social Development. 2011 will witness the start of the biggest health care reforms for 20 years with

a budget of 460 billion roubles. The reforms will include information system development, renovation and re-equipping of medical institutions, the raising of salaries for medical workers and standardization of medical services. The state is taking a number of measures to increase financial support for the health care sphere (through the programme for

the supply of essential medicinal drugs, the hospital segment and state procurement). In this respect, in view of the aging population and the consequent growing requirement for medicines, consumer expenditure on medicines is set to increase. All of these factors point to the potential growth of the pharmaceutical market as a whole over the next few years.

Survey of the Pharmaceutical Industry in Russia, 2010

Reform of the pharmaceutical sector

Key legislative changes
The Strategy for the Development of the Pharmaceutical Market of the Russian Federation in the Period up to 2020, which was adopted in 2009, signalled a transition to an innovative model for the development of the pharmaceutical industry of the Russian Federation. At present, as part of the first stage of the transition aimed at the localization of the manufacturing and development of medicinal drugs in the territory of the Russian Federation, the Government is implementing reforms to the regulation of Russias pharmaceutical industry. The most significant events of 2010 in the area of the state regulation of the Russian pharmaceutical industry may be identified as follows: The adoption of Law No. 61-FZ Concerning the Circulation of Medicinal Drugs The issuance of Decree No. 865 of the Russian Government of October 29, 2010 Concerning the State Regulation of Prices for Medicinal Products Included in the List of Vital and Essential Medicinal Products The adoption of Federal Law No. 326-FZ Concerning Compulsory Medical Insurance in the Russian Federation The development of the draft law Concerning the Fundamental Principles of the Protection of the Health of Citizens in the Russian Federation The approval in October 2010 of the Conceptual Plan of the Federal SpecialPurpose Programme (FSP) Development of the Pharmaceutical and Medical Industry of the Russian Federation in the Period up to 2020 and Beyond (the Conceptual Plan has now been approved by Decree No. 91 of the Government of the Russian Federation of February 17, 2011) The FSP has defined the major measures of the development of the pharmaceutical industry of the Russian Federation, including raising the proportion of domestically manufactured drugs to 50% of total consumption in the Russian Federation in monetary terms and raising the proportion of domestically manufactured drugs to 90% of total consumption of products on the list of vital and essential medicinal products in monetary terms. The FSP envisages investment of 188 billion roubles in the period up to 2020. Special measures are planned to improve the competitiveness of domestic medicines and replace imports. Those measures include: Tough price restrictions on medicinal products included in the list of vital and essential medicinal products The adoption of a list of strategically important medicinal products whose production within Russia must be arranged by 2015, and updating of the list of vital and essential medicinal products Planned transition to international standards for the manufacture of medicinal drugs. Figure 3. How have the recent changes in legislation governing the circulation of medicinal drugs affected your companys nancial results?
100% 90% 80% % respondents 70% 60% 50% 40% 30% 20% 10% 0

Effects of regulatory measures in 2010

Measures adopted in 2010 for the state regulation of the sector have affected Russian and foreign manufacturers in different ways. This is particularly the case with Law No. 61-FZ Concerning the Circulation of Medicinal Drugs. 63% of respondents indicated that the measures carried out for the regulation of the industry affected their financial performance. Legislative changes led to a growth in sales and reduction in profitability for 33% of Russian manufacturers surveyed, and to a decrease in sales and reduced profitability for 38% of foreign manufacturers-importers (Figure 3)

6,3% 25% 33,3%

16,7% 37,5%

50% 31,3%
Foreign manufacturers / importers Russian manufacturers

Increased sales and higher prot margins Increased sales and lower prot margins Decreased sales and lower prot margins No effect

Survey of the Pharmaceutical Industry in Russia, 2010

Both foreign and Russian manufacturers encountered difficulties in 2010 in connection with the new rules governing the circulation of medicinal drugs. The problems most frequently encountered as a result of the new law are with obtaining state registration of medicinal products, registering maximum manufacturer supply prices for products on the list of vital and essential medicinal products, obtaining confirmation of the registration of a medicinal product and making changes to the registration file for such a product. In this respect, a greater proportion of Russian manufacturers than foreign indicated difficulties with the state registration of products and the registration of maximum prices for vital and essential medicinal products. In particular, difficulties with the registration of products were claimed by 57% of foreign and 83% of domestic manufacturers.

Regulation of prices for products on the list of vital and essential medicinal products
At the business dinner organized by Ernst & Young at the beginning of 2010, senior executives of various pharmaceutical companies discussed the prospects for changes to the rules for price regulation in the Russian Federation. They expressed doubts as to the ability of state authorities to implement changes in the industry within a short period of time and as to whether the new pricing conditions would be transparent for all market participants. Despite the rapidity with which the changes were brought in and the strict monitoring of compliance with the rules in 2010, 95% of all manufacturers managed under the new regulatory environment to register maximum supply prices for all products on the list of vital and essential medicinal products, and indeed most respondents (70%) did so at the prices stated in their applications. In contrast to foreign manufacturers, which registered prices for all items, 17% of Russian manufacturers were unable to reach agreement with the supervisory authorities on a number of items. However, 29% of foreign manufacturers were forced to reduce the prices for a number of items. Among Russian manufacturers this happened to 17% of respondents.

Figure 4. Which changes in regulation have led to the most difculties for your company?
State registration of medicinal products Registration of maximum supply prices for products from the list of vital and essential medicinal products Conrmation of the registration of a medicinal product and making amendments to the registration le for a medicinal product Obtaining authorization to conduct clinical trials Obtaining authorization to import medicinal products for the purpose of conducting clinical trials Compliance with maximum regional wholesale mark-ups for products from the list of vital and essential medicinal products Peparation of pricing protocols upon the sale products from the list of vital and essential medicinal products Other (constant update of the register of medicinal products and inclusion of pharmaceutical substances in the register) 0 Foreign manufacturers / importers Russian manufacturers

57% 83% 57% 67% 29% 50% 21% 17% 21% 17% 14% 0% 21% 0% 0% 17%
20% 40% 60% 80% 100%

% respondents

Survey of the Pharmaceutical Industry in Russia, 2010

Figure 5. Did you succeed in registering maximum supply prices for all products supplied by your company?
100% 90% 80% % respondents 70% 60% 50% 40% 30% 20% 10% 0 All Foreign manufacturers / importers

5% 25% 29%

17% 17%

30%

21% 50%

40%

50% 17%
Russian manufacturers

A more pronounced reduction of prices for products of foreign manufacturers (Figure 3) was also noted by market analysts. According to CMI Pharmexpert, the regulation of supply prices and of wholesale and retail mark-ups caused the average level of prices on the commercial retail market to fall in 2010. In this respect, prices for imported products fell by an average of 4.5%, while those for Russian products actually increased by 4% over 2010. The explanation given by CMI Pharmexpert analysts for this is that Russian manufacturers partially compensated for the decrease in retail prices for products on the list of vital and essential medicinal products by increasing prices for other drugs.

Yes, all our products have been registered at the declared prices Yes, but we had to negotiate with the relevant authorities Yes, but we were forced to reduce the prices for a number of items No, have been unable to reach agreement with the supervisory authorities on a number of items

Figure 6. Have you considered discontinuing the production of particular pharmaceutical products in Russia owing to the fact that they have been registered at a low price and it is therefore commercially inefcient for the products to be distributed in Russia?
% respondents (excluduing those, who have no vital and essential medicinal products) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0 Foreign manufacturers / importers Yes No

14%

67% 86%

On the other hand, Russian manufacturers produce medicines which are in a lower price segment, which means that there is probably less scope for reducing profit margins. The survey data indicate that the reduction of supply prices was more painful for Russian than for foreign manufacturers. 67% of Russian manufacturers (compared with only 14% of foreign) were considering whether to discontinue the production of certain drugs on the basis that price reductions made it commercially inefficient (Figure 6).

33%
Russian manufacturers

Survey of the Pharmaceutical Industry in Russia, 2010

Both Russian and foreign manufacturers express displeasure at the current price regulation framework. 50% of those surveyed are inclined to the view that the price regulation system as it stands could result in the discontinuation of supplies of certain medicinal products to Russia and the laundering of cheap pharmaceuticals. This is due to the fact that the price reductions hit products in the lower price segment which have a lower margin.

Figure 7. How do you assess the situation with regard to the state regulation of prices for pharmaceutical products in Russia? 73% 67% 53% 50% 27% 0% 13% 0% 13% 0% 0% 17% 0% 17%
0 Foreign manufacturers / importers Russian manufacturers 20% 40% 60% 80% 100%

Current price regulation is ineffective and needs to be reviewed Current price regulation may result in the cessation of supplies of certain medicinal products to Russia and the laundering of cheap pharmaceutical products Current price regulation favours Russian manufacturers Current price regulation is favourable to distributors Current price regulation is effective and no changes are needed Current regulation of supply prices causes retail prices to be reduced

Compulsory medical insurance

The law Concerning Compulsory Medical Insurance in the Russian Federation entered into force from January 1, 2011. It envisages a gradual change in the system of compulsory medical insurance and health care in the Russian Federation, and likewise has a significant impact on participants in the pharmaceutical market. Manufacturers expect to see changes in the structure of the market both in terms of the transformation of product segments and from the point of view of the position of major players. 83% of Russian manufacturers expect to see a cardinal change in the relative market shares of the major players as a result of the new law. In this respect, most foreign manufacturers are more concerned by the fact that manufacturers of cheap non-branded products might assume a leading position on the market (Figure 8).

Other

% respondents

Figure 8. How do you assess the impact of the compulsory medical insurance law on the Russian pharmaceutical market?
There will be a cardinal change in the distribution of shares among the main players Manufacturers of cheap non-branded products might gain a leading position on the market The effect will be negligible

31% 83% 46% 0% 15% 17% 8% 0%

0 20% 40% 60% 80% 100%

Other

Foreign manufacturers / importers Russian manufacturers

% respondents

10

Survey of the Pharmaceutical Industry in Russia, 2010

75% of Russian manufacturers believe that they will gain from the adoption of the law, while more than half of foreign manufacturers believe that the new law will not affect their activities (Figure 9).

Figure 9. Have you assessed the impact of the compulsory medical insurance law on your company?
100% 90% 80% % respondents 70% 60% 50% 40% 30% 20% 10% 0 All Foreign manaufacturers / importers

13%

18% 27%

40%

75%

47%

55% 25%
Russian manufacturers

Yes, the new law will have a negative impact on our companys activities Yes, our company will gain from the adoption of the law No, the law will not have any impact on our companys activities

Clinical research
The survey results indicate that Russian manufacturers conduct 50% of clinical research independently and 50% with the aid of specialized companies. Foreign manufacturers use specialized companies for the majority of their research (60%). According to data from the Association of Clinical Research Organizations (ACRO), the Russian market for international clinical research shrank by 25% in 2010. ACRO attributes that decline to the enactment of the Law on the Circulation of Medicinal Drugs, administrative barriers caused by the adoption of that Law and the need for appropriate regulatory bylaws. ACRO representatives fear that this could result in significant delays in the appearance of innovative medicines in Russia.

Figure 10. Do you conduct / organize clinical research in Russia?

100% 90% 80% % respondents 70% 60% 50% 40% 30% 20% 10% 0 All Foreign manufacturers / importers Russuian manufacturers

5% 38%

7% 33% 50%

57%

60%

50%

No, we do not conduct clinical trials in Russia Yes, we conduct clinical trials ourselves Yes, we conduct clinical trials with the aid of specialized companies

Survey of the Pharmaceutical Industry in Russia, 2010

11

However, most survey participants (47% of foreign and 67% of Russian manufacturers) responded negatively to the question of whether it would be possible to restructure clinical trials of new medicines. On the whole, therefore, the current situation is forcing manufacturers to cut down on trials of innovative products. However, only 40% of foreign manufacturers have plans to review this area of activity in Russia in the future.

Figure 11. Have you considered the need to restructure clinical research arrangements in connection with the enactment as from September 1, 2010 of the new law on the circulation of medicinal drugs?
100% 90% 80% % respondents 70% 60% 50% 40% 30% 20% 10% 0

57%

53%

67%

38% 5%
All

40% 33% 7%
Foreign manufacturers / importers Russian manufacturers

No Yes Our company does not conduct / organize clinical trials in Russia

12

Survey of the Pharmaceutical Industry in Russia, 2010

Manufacturers reactions to regulatory measures

The changes in the system of regulation meet with different reactions from foreign and Russian manufacturers. Foreign manufacturers are forced to revise their model for doing business in Russia, while their Russian counterparts only have to update their commercial and marketing strategy. Specifically, 53% of foreign manufacturers consider it necessary to change their business model. 43% of foreign manufacturers view the impending introduction of criteria for defining a domestic medicinal product as a serious problem. For Russian manufacturers, meanwhile, the most serious problems are updating their commercial and marketing strategy (indicated by 50% of Russian manufacturers) and negotiating with state authorities (67%) (Figure 12).

Figure 12. Indicate the most serious problems faced by your company in light of the proposed changes in the regulation of the industry.

Updating the companys business model

53% 33% 40% 50% 47% 33% 27% 67% 27% 0% 13% 33% 27% 0% 0% 17% 0% 17%
0 20% 40% 60% 80% 100%

Updating the companys marketing and commercial strategy Proposed introduction of criteria for dening a domestic medicinal product Holding talks with State authorities

Modifying arrangements with Russian distributors Studying operating conditions in regions of the Russian Federation

Production localization

Raising the companys awareness of regulatory issues

Other

Foreign manufacturers / importers Russian manufacturers

% respondents

60% of Russian and 46% of foreign manufacturers are conscious of support given to domestic manufacturers. Russian manufacturers point in particular to the 15% preferences in the area of state procurements which are granted on the basis of Federal Law No. 94-FZ Concerning the Placing of Orders for Supplies of Goods, Performance of Work and Rendering of Services for State and Municipal Needs and have been in effect for a number of years.

Figure 13. Are you conscious of support given to domestic manufacturers?

100% 90% 80% % respondents 70% 60% 50% 40% 30% 20% 10% 0 Foreign manufacturers / importers Yes No Russian manufacturers

46%

60%

54%

40%

Survey of the Pharmaceutical Industry in Russia, 2010

13

Factors affecting the development of the industry in 2010

Adverse factors affecting companies activities
At present the survey participants view the overall picture as promising in the context of the adoption of the 2020 Strategy. At the same time, they point to the problems and difficulties faced in the transitional period. Paramount among those problems are unfavourable legislation, a shortage of professional personnel, corruption and general economic conditions (Figure 14). Representatives of both Russian and foreign companies view the impact of legislation on their activities as the most important factor. In this respect, they draw attention to the adverse effects and the need to rectify the situation. Since they do not yet have large-scale localized manufacturing operations in Russia, foreign manufacturers are less dependent on the skill level of pharmaceutical production staff, and yet they point to the lack of qualified personnel just as local producers do 63% against 83% of respondents respectively. Curiously, even in the context of the economic downturn neither local nor global players refer to problems with financing only 13% of companies indicated this as a negative factor. Similarly, only 21% of respondents are worried by the growth in competition. Despite this low relative assessment, however, in absolute terms competition is rated as higher than average in all segments (Figure 17). Figure 14. Which of the following factors represent the greatest threat to the industry? 75% 100% 63% 83% 69% 33% 25% 50% 31% 17% 25% 17% 6% 17%
0 Foreign manufacturers / importers Russian manufacturers 20% 40% 60% 80% 100%

Unfavourable legislation

Lack of qualied personnel

Corruption

General economic conditions

Circulation of counterfeit products

Growth of competition

Lack of investment / nancing

% respondents

Shortage of skilled personnel

Research results for 2010 indicate that the shortage of skilled personnel on the Russian labour market continues to be one of the most acute problems facing the pharmaceutical industry a view expressed by 71% of all respondents. The results of the survey indicate that for the moment this is more of a problem for Russian participants in the market than for foreign importers. 83% of Russian manufacturers are concerned at the lack of skilled personnel in the Russian Federation, compared with 63% of foreign manufacturers-importers (Figure 14). The personnel shortage is expected to become a more acute problem for foreign manufacturers in view of the trend towards the localization of manufacturing in the Russian Federation in the next few years under the influence of import substitution policies. Some of them have already turned their attention to this problem: participation in the process of the harmonization of educational programmes and the training of highly qualified personnel is on the list of business development priorities noted by foreign manufacturers in the course of the survey.

14

Survey of the Pharmaceutical Industry in Russia, 2010

With a view to addressing this problem in the context of the implementation of the strategy for the development of the industry in pharmaceutical cluster regions of the Russian Federation there are plans to invest in the development of personnel potential, which involves the launching of new educational programmes and co-operation with leading Russian medical and pharmaceutical centres and international educational centres. According to the federal special-purpose programme, 5000 specialists are to undergo training and retraining by 2020 in order to provide staff for enterprises of the pharmaceutical industry.

Interaction with the state

One of the conclusions drawn on the basis of the year 2010 by senior executives of foreign companies who took part in the business dinner was a conscious need to improve dialogue between the business world and the state. The survey results show that representatives of Russian and foreign companies place equal value on the

role of professional associations in the field (83% and 73% respectively). In this respect, Russian and foreign manufacturers have different attitudes to the making of private representations to state authorities. 100% of Russian companies surveyed use this approach, compared to only 33% of foreign companies.

Figure 15. Assessment of most effective methods of communication between pharmaceutical companies and the State 76% 73% 83% 52% 33% 100% 10% 13% 0% 10%
Other

Corruption
The survey results show that foreign companies see corruption in Russia as the second biggest problem for the industry. Russian companies, meanwhile, place corruption in fourth place in the list of threats faced by the industry (Figure 14). This difference in assessments is easily explained foreign companies pay greater attention to the problem of corruption owing to the long-standing culture of ethical business practices based on their own internal policies and the requirements of regulatory acts such as the US Foreign Corrupt Practices Act. That Act and similar acts adopted in other countries have an impact on the way in which foreign companies do business in Russia. For instance, under the UK Bribery Act any companies which do business in Great Britain may be prosecuted for the corrupt practices of their partners. For this reason companies class the management of corruption risks as a priority objective.

Non-commercial organizations / associations of pharmaceutical companies

Private communications from individual companies to representatives of State authorities

Open communications in the independent press

13% 0%
0 20% 40% 60% 80% 100%

All Foreign manufacturers / importers Russian manufacturers

% respondents

Survey of the Pharmaceutical Industry in Russia, 2010

15

Analysis of market development

Distribution of the market shares of major players
According to data from industry experts consisting of sales figures for the year 2010 expressed in monetary terms, the 15 largest companies (an absolute majority of them being foreign companies) control around 46% of the market. The remaining 54% of the market is divided up between a large number of Russian and foreign players. The experts consider that this shows that the market is fragmented and likely to undergo further consolidation. Figure 16. The market shares of the 15 largest pharmaceutical companies based on revenues for 2010 Despite the fact that the respondents indicated changes in sales volumes and profitability in 2010 (Figure 3), these movements were not reflected in respective market shares. The shifts in positions among companies on the top 15 list (during 2009-2010) corroborate the view of the survey participants that competition for top places is more acute among foreign players.

Assessment of competition on the market

The survey results indicate that, as things stand, 25% of foreign manufacturers and only 17% of Russian manufacturers class competition as a risk factor (Figure 14). This is probably due to the fact that only one Russian manufacturer is on the list of the 15 largest companies (in terms of revenue levels) and is competing for top places with the other 14 foreign players. The survey participants rate the level of competition in particular segments as follows: Competition was rated as greater than average (i.e. not lower than 3.4 points out of 5) in all segments

Market forecasts
Foreign and Russian manufacturers who took part in the survey have divided opinions regarding the prospects for changes in the respective shares of market players. To the question of how the pharmaceutical market will develop in Russia over the next five years, Russian manufacturers answer that the share of Russian companies will naturally increase thanks to state support. Furthermore, state support will, in their opinion, encourage foreign manufacturers to create production enterprises in Russia. 44% of foreign manufacturers envisage setting up production operations in Russia, while they regard other possible developments, such as the acquisition of Russian companies, as less likely (only 18% of respondents mention such possibilities). It may be assumed that a qualitative change in the distribution of forces will begin in 2011, aided by the following factors:

46% 54%

The highest level of competition was in the Russian distributor segment, while the lowest was in the local manufacturer segment.

15 largest companies Other

Source: CMI Pharmexpert, analysis by Ernst & Young

Figure 17. Rate the level of competition within segments of the Russian pharmaceutical market on a scale of 1 to 5. 4,0 3,8 3,4 3,5
1 All 2 3 4 5

Russian distributors

There were no significant changes in the distribution of market shares in 2010 compared with 2009. The combined market share of the 15 largest manufacturers remained virtually unchanged (the difference was just slightly above 1%). Virtually all 15 key manufacturers retained their places, with partial shifts in position within the group.

Foreign manufacturers / importers Russian manufacturers Pharmacy networks

16

Survey of the Pharmaceutical Industry in Russia, 2010

 The nascent localization of the manufacturing of foreign products The further growth in competition and existing defragmented state of the market The effect of price regulation and compulsory medical insurance laws adopted in 2010 The already formulated strategy for the development of the pharmaceutical industry and the federal special-purpose programme.

Figure 18. Which of the forms of business development listed below is your company considering? (Russian companies)
Introduction of new products to the market Extention of existing production facilities Building of new production sites Entering foreign markets Acquisition of other manufacturers Contract manufacturing Own wholesale distribution development No such plans

100% 83% 67% 50% 33% 33% 0% 0%

0 20% 40% 60% 80% 100%

100%

Forms of business development and trends towards localization of manufacturing

The survey results indicate that the majority of Russian manufacturers (83%) plan to expand their existing production facilities, and two thirds of those surveyed (67%) intend to begin building new production sites. In view of the state import substitution strategy foreign companies are generally considering two main business development scenarios. Half of foreign companies express an interest in setting up their own production operations in Russia. Slightly less interest is shown by foreign companies in establishing contract manufacturing with Russian manufacturers around 44% of respondents (Figure 19). Contract manufacturing may become more attractive in the future thanks to state support for the process of the transition to international manufacturing standards (GMP). The survey results show that foreign companies have little interest in closer co-operation with Russian manufacturers, e.g. through the transfer of patents and technologies. There are currently only a very few examples of such co-operation on the market. At present, many major foreign players on the market are already at various stages of

Russian manufacturers

% respondents

Figure 19. Which of the forms of business development listed below is your company considering? (foreign companies)
Introduction of new products to the market Setting up own production operations in Russia Contract manufacturing Transfer of a patent for an end product and/or the technology for its manufacture in the territory of the Russian Federation to a Russian legal entity Other No such plans

94% 100% 50% 44% 13% 6% 0%

0 20% 40% 60% 80% 100%

Foreign manufacturers / importers

% respondents

production localization: they have announced their investment intentions or have already begun construction. The survey results show that foreign pharmaceutical companies tend to choose Saint Petersburg, Yaroslavl and Kaluga as the

most preferred places to set up production (these cities were mentioned by respondents three times more often than any others in the course of the survey).

Survey of the Pharmaceutical Industry in Russia, 2010

17

Figure 20. Do you plan to set up a production enterprise in one of the pharmaceutical centres (clusters), such as Saint Petersburg, Yaroslavl and Kaluga?
100% 90% 80% % respondents 70% 60% 50% 40% 30% 20% 10% 0 Foreign manufacturers / importers Russian manufacturers

13% 13% 7% 27%

17%

33%

40%

50%

The survey results are consistent with actually announced investment projects, in which the Yaroslavl and Kaluga provinces and Saint Petersburg are chosen as locations for production operations. In particular, according to data from the Committee for Economic Development, Industrial Policy and Trade of Saint Petersburg, nine investment projects were initiated during 2010 for the construction of new factories in the city in addition to the seven already existing medicine manufacturing organizations.

Wholesale distribution market

The wholesale distribution market may be tentatively divided into two segments: The market of medium and small distributors, characterised by a high level of competition as also noted by analysts of DSM Group The market of large national companies, in which the top positions are held by five major enterprises which are represented in all regions of Russia and have a far-reaching distribution system. There is a fairly high degree of concentration in the second market segment, owing partly to the fact that top companies have increased the proportion of indirect sales, and particularly sales to smaller wholesalers. Strict regulation and monitoring of compliance with maximum wholesale markets have made things even tougher for small and medium-sized distributors. Russian distributors have divided opinions regarding the business prospects of medium/small distributors: 80% of manufacturers believe that small and mediumsized distributors will be taken over by large players, while 20% take the view that small wholesalers will simply be squeezed out of the market (Figure 21).

Yes, we are examining the opportunities in one of the pharmaceutical centres and (or) have already concluded an investment agreement in one of the pharmaceutical centres No, we have no plans to localize production activity in Russia No, we have no expansion plans to other Russian regions We are examining the opportunities in other regions of Russia and (or) have already concluded an investment agreement in another region of Russia Other

Figure 21. How do you assess the business prospects of medium / small distributors?
100% 90% 80% % respondents 70% 60% 50% 40% 30% 20% 10% 0 There will be market consolidation, medium/small distributors wil be aquired by large players Russian manufacturers

80%

20%
Medium/small distributors will be squeezed out of the market

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Survey of the Pharmaceutical Industry in Russia, 2010

The survey results show that legislative changes have affected foreign manufacturers relationships with distributors more than Russian manufacturers relationships with them. In this respect, 40% of foreign manufacturers believe that relationships within the supply chain have changed in favour of distributors (Figure 22).

Figure 22. Have relationships within the manufacturer-distributor chain changed as a result of changes in the legislation governing the circulation of medicinal drugs?
100% 90% 80% % respondents 70% 60% 50% 40% 30% 20% 10% 0 All Foreign manufacturers / importers Russian manufacturers

10% 33%

7%

20% 20%

40%

57%

53%

60%

Changed in favour of manufacturers Changed in favour of distributors No change

Survey of the Pharmaceutical Industry in Russia, 2010

19

Participants in the survey

The respondents most comprised foreign manufacturer-importers (67% of those surveyed) and Russian manufacturers of pharmaceutical products (25%). The remaining 8% of survey participants were Russian distributors of pharmaceutical products and pharmacy networks. Figure 23. Composition of respondents

8% 25%

67%

Foreign manufacturers / importers Russian manufacturers Russian distributors and pharmacy networks

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Survey of the Pharmaceutical Industry in Russia, 2010

Contact information
Dmitry Khalilov Partner, Tax Services Head of Pharmaceutical Group in the CIS Tel.: +7 (495) 755 9757 Dmitry.Khalilov@ru.ey.com Evgenia Veter Partner, Tax Services, Pharmaceutical Group Tel.: +7 (495) 660 4880 Evgenia.Veter@ru.ey.com

Tatiana Shustova Partner, Transaction Advisory Services, Pharmaceutical Group Tel.: +7 (495) 755 9867 Tatiana.Shustova@ru.ey.com

Sergei Stefanishin Partner, Legal Services, Pharmaceutical Group Tel.: +7 (495) 755 9872 Sergey.Stefanishin@ru.ey.com

Ivan Butyagin Partner, Advisory Services, Pharmaceutical Group Tel.: +7 (495) 705 9713 Ivan.Butyagin@ru.ey.com

Alexander Khorovitch Director, Audit Services, Pharmaceutical Group Tel.: +7 (495) 755 9844 Alexander.Khorovitch@ru.ey.com

The information contained in this publication is presented in abridged form and is intended only for general guidance. It must not be regarded as a substitute for a detailed survey report or other referenced materials or serve as the basis for a professional judgement. Ernst & Young cannot accept any responsibility for losses incurred by any person acting or refraining from action as a result of any material in this publication. Advice on specific matters should be sought from a specialist in the relevant field.

Survey of the Pharmaceutical Industry in Russia, 2010

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