Russia’s Support of Domestic Production as a Key Element in the Development of its Pharmaceutical Industry: Opportunities and risks for international players

Print 17 July 2014
Igor Petrushin, Head of Market Research and Consulting Division, Aston Consulting / Pharma Boardroom

The best of us have a late development. When in school, I was a moron. –Anthony Hopkins

Since 2012, a 15% preferential contract price has been granted to domestic producers bidding in government tenders. Currently, there are plans to increase this preferential pricing by up to 40% of the total contract price.

The process for public procurement is defined by Federal Law and the granting of preferences is determined by order of the Ministry of Economic Development. The mechanism behind the provision of preferential prices is quite simple: in a government tender, if a foreign supplier of pharmaceutical products is declared the winning bidder, then the contract price of the bid is automatically calculated at 15% below the originally proposed price. In case a foreign company offers the same price as any of the domestic drug manufacturers, the winning bid is then awarded to the domestic producer.

Domestic (Russian) drugs are defined in the regulatory documents as those whose country of origin is Russia. According to the regulations of the Customs Code of the Russian Federation, the country of origin is a place where the products have been manufactured or have undergone sufficient processing. This may also imply a group of countries, a customs union, a region or a certain part of the country, if there is a need to treat them as a separate entities for the purposes of determining the origin of goods.

At the moment, the packaging of imported finished pharmaceutical goods within the territory of the Russian Federation is considered sufficient processing. Any medicines packaged in Russia are therefore treated as domestically produced pharmaceuticals.

By introducing such legal provisions, Russian authorities aim to support domestic manufacturers, while at the same time pressuring foreign pharmaceutical producers to invest in Russia. The results have proven successful, as foreign pharmaceutical companies have started to localize their production in Russia by building plants of their own, buying existing facilities or arranging the production of certain drugs using the local production base (pharmaceutical outsourcing).

Some of the foreign companies that have localized manufacturing of their products in Russia

For some of these companies the decision to establish manufacturing in Russia was clearly induced by the need to optimize costs (logistics, etc.) and secure a strong market position in this country (e.g. for Stada the Russian market is its second largest in terms of sales after Germany). However, the driving force for massive localization was a consistent government policy of import substitution. Out of five hundred foreign companies that have been operating in Russia to date, the domestic production of pharmaceutical forms was initiated by approximately 50 of them. Of those 50, near 20 have already established full-cycle production, while the other thirty have opted for contract manufacturing and approximately the same number have utilized processing capabilities for primary and secondary packaging.

In this context, a regulatory framework that fosters localization of production in Russia coupled with increased government healthcare spending in coming years, provides foreign companies reassurances of a return on investment for the construction of pharmaceutical plants in Russia.

Total Market Sales (2013-2018) USD* (million), IMS Health

Note: Russia is the 6th largest world economy in terms of GDP. In 2012 (according to the IFPMA) Russia was among the top ten countries regarding the size of the pharmaceutical market. By 2018, this market is expected to grow by nearly 50% and will be worth 26 billion USD.

At the same time, import substitution and support for domestic manufacturers is only one of the important elements of the state policy concerning the pharmaceutical industry. To get a better idea of how this approach might evolve in the future, it is necessary to take a comprehensive look at the government policy of drug provision in general.

As early as 1997, a number of distinct development patterns for the pharmaceutical industry were set out in the National Security Concept of the Russian Federation which was approved the same year. The Concept agenda, among others, included the following priorities:

-       ensure a full production cycle of strategically important medicines within the territory of the Russian Federation

-       encourage the manufacturers of pharmaceutical products to establish domestic R&D centers for drug development in the Russian Federation

After twelve years, in 2009, a strategy for the development of the pharmaceutical industry until 2020 (also known as Pharma 2020) was approved and introduced at a national level. It was designed to create favorable conditions for the industry transition to an innovative development model.

Implementing this new model will involve enhanced development of the scientific and industrial sectors of the Russian pharmaceutical market, which is supposed to increase the share of unique and innovative products in the portfolio of local producers by up to 60% in value terms by 2020. It will also boost the competitiveness of the domestic pharmaceutical industry at the international level and will raise the export of medications by eight times compared to 2008 levels.

This strategy also sets out the following targets:

-       increase the share of locally produced drugs in the domestic market to 50% in value terms,

-       ensure national drug security of the Russian Federation with regard to the nomenclature of strategically important medicines and vaccines

-       encourage production of pharmaceutical substances within the territory of the Russian Federation to guarantee that 50% of all finished pharmaceutical forms (in value terms) are manufactured domestically, including not less than 85% of the medicines listed in the strategic drugs list.

Currently, the pharmaceutical industry in Russia consumes about 12,000 conventional tons of pharmaceutical substances per year of which approximately 2,500 tons are produced by domestic manufacturers. The resulting deficit is covered by imported products. The two main countries responsible for the supply of these compounds to the Russian market are India and China (around 80% of total imports). In comparison, in 1992 Russia was producing 272 pharmaceutical substances which amounted to 17.000 conventional tons. The level of saturation of locally manufactured products thus ranged from 70% to 100% and a significant portion of them were exported to other countries. This goes to show that during the period from 1992 to 2008 the volume of production of pharmaceutical substances in the Russian Federation decreased more than 10-fold.

The share of biotechnological and high-tech substances (that require at least 6 synthesis steps) used for production purposes in Russia is not more than 2% and 5% of the market respectively (in value terms), i.e. not exceeding 7% in total. To reach the targets set by Pharma 2020 with regard to the production of substances, the focus should remain on these two categories as opposed to the “plain” substances offered by India and China, which are hard for Russian producers to compete with in terms of price.

Of course, the current level of localization cannot be considered sufficient to achieve these ambitious goals with regards to innovation. The emergence of localization among foreign companies is likely to entail differentiated approaches toward the preferential treatment of domestic producers and will be closely linked to the degrees of localization of each company. As a result, foreign companies will be choosing their strategy and making a decision as to what is more profitable for them – whether to further localize production, spending more but also gaining greater preferences, or continue importing substances abroad, while risking their entitlement for preferential pricing.

Earlier this year the Ministry of Industry and Trade, proposed to use a selective approach to price preferences depending on the degree of production localization. According to this proposal, 15% preferential pricing would be offered to companies that have set up packaging operations in Russia (valid until the end of 2014). In contrast, manufacturers of finished pharmaceutical forms who utilize local capacities may count with a 30% discount and those companies that have been able to create a full production cycle in Russia, including the manufacturing of pharmaceutical substances, will be granted a 40% preferential price.

In our opinion, the declared principle “the more you invest locally, the more you get in return” will be consistently pursued and applied throughout the industry.

In conclusion

The issue of modernization is one of the key priorities of Russia’s current policy for the pharmaceutical industry. Through its plans to expand pharmaceutical production in the country, the government aims to forward increased revenues to the state budget at all levels. This will require the introduction of new pharmaceutical technologies that are non-existent in Russia, attracting qualified personnel capable of reproducing and utilizing these technologies, and ensuring national drug security by producing a significant portion of strategic drugs domestically. By accomplishing this in the future, Russia will become a global center for pharmaceutical R&D and innovative production.

Changes to the pharmaceutical sector are now visible through the close cooperation between the state and industry, with multinational companies playing a crucial role in these exchanges. In return for investing in local manufacturing and the transfer of technology, foreign companies can expect wider market opportunities.

The risks for companies localizing their production in Russia have been successfully minimized thanks to the attention on the part of the government, including Russia’s accession to the WTO through wich the non-discrimination principle has been withdrawn from the provision regarding government procurement and price regulation of medicines.

The sensitive issue of international sanctions on certain sectors of the Russian economy is not of great significance for the pharmaceutical market. First, the history of sanctions demonstrates that the West has no intentions to damage its own business opportunities, and secondly, the level of interest by Western pharmaceutical companies in the Russian market continues to be very high, and their leading positions remain undisputed. Just this fact alone makes us confident that the pharmaceutical industry will continue to evolve and possible sanctions will have little to no effect on it.

Of course, it goes without saying that the current macroeconomic situation does not paint the brightest future. Nevertheless, the observed trends are not indicative of any intentions to revise strategic plans and targets for the Russian pharmaceutical market. There is an assurance that the promised budgetary allocations for government drug procurement and the development of the domestic pharmaceutical industry will be kept intact and executed in full compliance with established goals. By 2016, the public funding of the healthcare system will grow by 10.4% compared with 2014.

Localization of production is viewed as an adequate strategy for those foreign manufacturers whose portfolio has a significant share of pharmaceutical products from the Essential Drugs List which is funded by the Russian government. In light of the possible introduction of broader drug reimbursement (national drug insurance plan) the focus on the local production looks promising in the long term as well.

The overall managerial and financial resources and efforts directed toward the development of the Russian pharmaceutical industry seem to suggest that in the next decade Russia will become one of the world centers for the development of pharmaceutical science and industry. This will happen through activities that are supported by various important players, including multinational companies, who will share the dividends with the Russian government and society.

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