Russian pharma: from distribution to
Trusted Sources > Russia > Macro policy

06 Sep 2007
Russia's pharmaceutical sector is aberrant in several respects. Total pharmaceutical spendingrelative to GDP is well below the OECD average, as this has not been a government priority. As aresult, private demand untypically accounts for the bulk of the drugs market. Despite being thusembedded into Russia's dynamic new retail sector, pharmaceuticals fail to ride the middle-classconsumer boom, since much of the natural demand comes from older and poorer people withless purchasing power. So the importers who dominate the Russian market, given the weaknessof domestic producers, do not treat this market as a top priority. The upshot - also unusual - isthat 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 attemptto boost pensioners' access to medicines (the "DLO" programme) and in theredeployment of Soviet-legacy strength in biotechnology to new drug discoveries. A modest sector with intriguing possibilities Trusted Judgements
Relevant Companies
High imports mean powerful distributors;
small market means small growth. Watch for
opportunities in applied biotech and IPOs
> Dr. Jan Dauman, CET-InterMatrix, sector-
Copyright Trusted Sources UK Ltd 2007-2012. All rights reserved. Russian pharma: from distribution to biotech
Trusted Sources > Russia > Macro policy Collapse and recovery
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. Importedpharmaceuticals poured in, despite their relatively high cost, and pharmacy kiosks selling themappeared alongside state-controlled drug dispensaries. The loss of a centralized procurementprocess left regional and municipal authorities scrambling - increasingly in overpriced retailmarkets - 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 paydrug producers was followed inevitably by short supplies, at least in the public sector. Federal andregional authorities compiled (wish) lists of "essential and life-saving" drugs and triedvainly to boost local production of the latter with tax exemptions. The financial crisis of 1998 dealta withering blow to infant relationships between Russian distributors and big foreignpharmaceutical producers. Gradual recovery has been under way for about a decade. According to the Federal StatisticsService, the percentage of household expenditure for "personal hygiene andmedicine" 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 growthtracks growth in real incomes, averaging about 11-13 per cent per year, which is roughly what themore sober industry-watchers estimate (see chart). To put the $11bn Russian pharmaceuticalmarket into context, the world-leading US pharmaceutical market reached about $330bn in 2006,and Italy's is projected to reach $30bn in 2007. Size of Russian pharmaceutical market (in US$bn)*
*2002-2007 figures use actual Rb exchange rates, 2008-2012 figures use Rb25=US$1 Copyright Trusted Sources UK Ltd 2007-2012. All rights reserved. Russian pharma: from distribution to biotech
Trusted Sources > Russia > Macro policy The 'DLO'
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's36 per cent annual jump from 2004-06 not being sustained. That surge was due to an anomalousboost the sector received from a government programme which is undergoing re-evaluation. Itsimpact is perhaps best revealed in a breakdown of sector sales (see chart) showing "federaland regional government sales" grew markedly with the 2005 injection of the DLO budget. Market share of federal and regional government sales, hospital sales, and commercial
sales (in per cent)
State provision of medicines for the poor is one of several areas of public welfare which the Putinadministration has tried to improve. This story began in 2004 as part of a wider reform to replacevarious in-kind entitlements with monetary transfers. In the case of prescription medicines, thebeneficiaries (mainly pensioners, together with some other deserving social groups) were giventhe alternative (to a monthly cash benefit) of eligibility to a free package of medicines defined inthe "Provision of Supplementary Medicines" programme, known in Russia by theabbreviation "DLO" (for more detail, click With its Rb50.8 billion first-year budget, the DLO immediately raised the international profile of theRussian pharmaceutical sector. In addition to putting real money behind spending commitmentswhich had previously been largely unfunded, that budget - boosted by transfers from thegovernment's oil-related fiscal windfalls - also increased the total spend, as the DLO encouragedthe 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 fora diabetes patient is a striking example: Russia's average annualincome in July 2007 was about$6,070. Unfortunately, this maiden attempt to boost Russian state support for health expendituresexperienced growing pains. These included funding miscalculations (medicines prescribed in2006 exceeded that year's budget by two-and-a-half times, reimbursements failed to coversupplier 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 Copyright Trusted Sources UK Ltd 2007-2012. All rights reserved. Russian pharma: from distribution to biotech
Trusted Sources > Russia > Macro policy drugs accounts for about 20 per cent of the market), market participants are generally discountingthe DLO's place in their future strategies. For example, DLO sales represented 8 per cent ofmanufacturer 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 bythe DLO as sixth out of six strategy elements and states explicitly: "our growth strategy doesnot depend on government healthcare expenditure." The first half of 2007 saw the first dropin import growth since 1998 as many importers shifted their shipment mix away from higher-enddrugs 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 centof the total volume) still prevail over domestically-produced, usually generic drugs. The hardiestlocal manufacturers persisted through the lean years and even occasionally invite takeovers fromforeigners seeking a foot in the door of Russian pharma. Industry-watcher DSM Group hasranked domestic production (whether by indigenous or foreign companies) by the value of H12007 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 Russian producers' revenues are modest in absolute terms, despite very fast growth. When thegovernment 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 theproportion is still only about 9 per cent domestic (DSM). In the case of a specific drug withconsistent public and private sector demand, some 97 per cent of insulin on the Russian marketis still imported, while much domestic production is working considerably below capacity(WebDigest).
Another part of the pharmaceutical sector looks more promising: this is distribution. There areabout seven major players in pharmaceutical distribution in Russia (see table below). These tookthe place of Soviet centralized procurement and serve as the missing link between retail andpublic-sector end-users, on the one hand, and the still overwhelmingly preferred foreign-importedpharmaceutical products, on the other. Essentially a specialist logistics and marketingmechanism, pharmaceutical distribution remains a scaleable and profitable business in its ownright, and there is some movement towards linkage with retail drugstore chains.
Russian pharmaceutical distributors, ranked by sales relative to the sector leader
Copyright Trusted Sources UK Ltd 2007-2012. All rights reserved. Russian pharma: from distribution to biotech
Trusted Sources > Russia > Macro policy Pharmacies
Russia's fast-moving retail revolution quickly extended to modern drugstores, which havereplaced the kiosks of the 1990s. Even though state-run dispensaries exist and indeed remainpowerful players in some regions (e.g., Ulyanovsk, St. Petersburg), retail drug-store chains arenow 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 integrationbetween 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 andRosta's chain Raduga. A less obvious but important link is the stake of retail-sector leader Apteka36.6 in the well-run generics producer Veropharm. There is also noticeable consolidation taking place within the sector, as drugstore chains build outinto the regions and buy out rival chains and independent stores. Apteka 36.6 is also moving inthis direction, having acquired eight regional chains in January 2007 and another 48-store chainin H2 2007.
Russian retail drugstore chains
most recent acquisitionof 48 additional storesfrom Zdravnik chain) Hundredyears (Saratov) with its 119 regional drugstores to") create a drugstore group rivalling 36.6 andRigla.
Ufa by purchasing a local chain in that city distribution network; owned by Penza rep toFederation Council, Boris Shpigel.
Copyright Trusted Sources UK Ltd 2007-2012. All rights reserved. Russian pharma: from distribution to biotech
Trusted Sources > Russia > Macro policy distributors, but benefiting from"considerable discounts fromAlliance" Source: Pharmexpert, unless otherwise indicated.
Copyright Trusted Sources UK Ltd 2007-2012. All rights reserved. Russian pharma: from distribution to biotech
Trusted Sources > Russia > Macro policy Trusted Judgements
Dr. Jan Dauman, CEO of CET-InterMatrix, a sector-specialist advisory and consultancy group
With imports prevailing over weak domestic production, distribution
remains the dominant business

Russia's pharmaceutical sector has not followed the standard development path. Typically, theopening of a market to international products means that, among the three key players -producers, distributors, and retailers - the middlemen distributing relatively higher-quality importsbegin as the strongest player. They gradually cede power to local producers, whose brands andproducts become important and recognizable, and to retailers, who gain in size and are able, byvirtue 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 in2004 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 canboast only Arbidol (a Tamiflu analogue) among quality products.
The weakness of the domestic production sector can be traced back to resource-allocationdecisions in the Soviet central-planning era, which concentrated R&D in pharmaceuticals inEast European satellite states. A very interesting possible exception can be found in thealternative to chemical pharma, which is pharmaceutical applications developed from abiotechnology research base which has its origins in the Soviet biological warfare programme, forwhich no expense was spared and the best scientists allocated. For now, applied biotech offersthe best prospects for the domestic production sector, even if no commercial applications havematerialized as yet.
A market dominated by importers is not that exciting for them
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 dominatethe Russian market for the foreseeable future. But importers are not always particularlyaggressive. There are various factors at work here. 1. Inadequate government spending on drug procurement means that the market is smaller andgrowing less fast than would be expected, given Russia's present national income and overalleconomic growth. So the Russian market is not a "life-changing" one for internationalpharmaceutical majors, in the sense of having a material marginal impact on their earningsperformance. Partly because medicines have always been a low public spending priority (despitemany 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 theface of ill-health. 2. There are non-trivial costs involved in promoting drugs with regional sales teams and medicalspecialists who introduce drugs to physicians; Russia's geographical size piles on logistical coststo man-power costs. 3. Heightened vigilance (largely US-driven) related to the Foreign Corrupt Practices Actincentivizes drug companies to de-prioritize regions where tendering processes invite, or merelyappear to invite, misbehaviour.
Copyright Trusted Sources UK Ltd 2007-2012. All rights reserved. Russian pharma: from distribution to biotech
Trusted Sources > Russia > Macro policy Nonetheless, watch for applied biotech and IPOs
In the meantime, as foreign imports continue to dominate, distributors with local knowledge whoare 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, andthey have grown sophisticated and specialized since then. (No such stimulating or discipliningforce has come to bear on Russia's domestic pharmaceutical producers.) Going forward, more consolidation will probably occur, although it is unlikely between producersand distributors, since distributors would not want to restrict their stable of products to those of asingle producer, and producers would not wish their products to be offered alongside those oftheir rivals. The more plausible consolidation is of distributors with retailers. Further deals are to be expectedalong the lines of Protek, the distribution market leader, establishing the Rigla pharmacy chainand of the recent acquisition of the Russian distributor Apteka Holding by Alliance Boots. Butsome of the distributors already have the scale and autonomy to make an IPO the more logicalexit for founding entrepreneurs. This may apply in particular to Protek and possibly SIA, the othermarket leader.
Besides applied biotech and distributors, areas well-placed for growth are private hospitals anddrugstore retail, which remain most exposed to the middle-class consumer boom. Copyright Trusted Sources UK Ltd 2007-2012. All rights reserved. Russian pharma: from distribution to biotech
Trusted Sources > Russia > Macro policy 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 actualmarket size is in fact quite small and production weak. Our trusted source stresses thegovernment's own pharma spend, low by international standards, as the key brake on the entiresector's development. Cause for encouragement is the reworked DLO, which, with its 2007budget boosted from Rb34.9bn to Rb68.2bn (US$2.5bn), seems to indicate the seriouscommitment the Russian government is at last prepared (and financially able) to make topharmaceutical procurement. Is the DLO the "first swallow of the spring"? Russia'sconvergence to international norms predicts this outcome, but companies are probably wise towait and watch for now. Our trusted source flags two intriguing possibilities. The first is that Russia retains a comparativeadvantage left over from Soviet-era biotechnology. Some insight into the drug-pipeline potential ofthis area is available through the International Science and Technology Center (ISTC),established by international agreement in 1992 as a nonproliferation programme, and now acoordinator of "the exceptional pool of scientific talent available in Russian and CISinstitutes" working on originally-military projects like anti-anthrax or anti-tumour drugs (for). The second point is the IPOs which are likely to come. Distributors Protek and SIA Internationalare plausible IPO candidates in the next 18 months, with the latter possibly also in the sights ofmajority 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 producersingled out for praise by our trusted source) and which runs an annual competition to attractinstitutional researchers with ideas to translate into sellable pharmaceutical products. This effortto draw upon home-grown R&D highlights the present backwardness of the sector - but alsoits genuine potential. Copyright Trusted Sources UK Ltd 2007-2012. All rights reserved. Russian pharma: from distribution to biotech
Trusted Sources > Russia > Macro policy Relevant Companies
About a sixth the size of the market leaders, distributor Shreya 9an arm of the above traded company) focuses on commercial and 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 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 German producer with acquired facilities (Nizhpharm, Hemopharm, Slovenian manufacturer with production facilities in Moscow 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.
Hungary-based drug manufacturer with best-selling pharmaceuticals 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 Copyright Trusted Sources UK Ltd 2007-2012. All rights reserved.


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