Pharmaceuticals in play: Rising domestic demand and export potential make the country an increasingly attractive market for drugs firms

The growth of Indonesia’s middle class has resulted in an increasing demand for branded pharmaceuticals. However, efforts to attract additional foreign investment into the pharmaceuticals industry are hampered by an array of challenges, including price controls, weak intellectual property (IP) law enforcement, corruption, lack of skilled labour and a poor regulatory framework. Competition in the generic drugs market is also set to intensify, as pharmaceuticals tariffs of 10% are eliminated among South-east Asian nations (by 2011, Indonesia was required to reduce this to zero in line with the rules of the ASEAN free-trade agreement).

GENERICS: The Indonesian government has traditionally favoured generics over branded products because of lower price points, going so far as to subsidise them. These subsidies came to Rp350bn ($42m) in 2009. As a result there is a larger market for generics than for branded products. Indeed, the government’s National Essential Drugs List (NEDL) is composed of generics only, as branded products are considered too costly. This in turn encourages prescribers to substitute generics for branded drugs in order to reduce the country’s overall drugs bill. The result of this state of play is a larger market for generic rather than branded pharmaceuticals.

Competition in both the generic and branded drugs market is set to intensify as well, as tariffs are eliminated across the ASEAN region while prices look on the rise locally. At the start of the year 2011, the Indonesian Pharmaceutical Manufacturers Association announced that 20 of its members had increased the price of some of their drugs considerably. In certain instances, the rise was as high as 10%. The rise in prices was reportedly a response to a gathering of external forces acting on the industry. These included, among other factors, a new import tax imposed on the raw materials necessary for drug manufacture, as well as pressures stemming from inflation and a rise in the minimum wage.

With competition expected to remain heavy for the foreseeable future, growth in the brand-name market will likely remain slow. The market for generics could expand, though customers might look to other ASEAN markets for cheaper products.

VALUE: According to Harry Su, senior vice-president and head of research at Bahana Securities, the Indonesian pharmaceuticals industry was valued at Rp37.8trn ($4.5bn) in 2010. The industry is fragmented, Su said, being distributed between over 200 companies, 58% of which are prescription and 42% OTC. With a 14% market share, Kalbe Farma is the largest company, with the next-biggest firms holding market shares of around 5% each.

With such a fragmented industry, many think the government should actively encourage a consolidation among the smaller players. On the face of it, this would make sense: local pharmaceutical firms would likely be in a good position to benefit from consolidation, as it would help increase their market share as well as reduce the number of competitors.

Indeed, Erwin Tenggono, the president director of Anugrah Argon Medica, told OBG in an interview that “the number of wholesalers is too high in Indonesia, considering that only a few of them own the majority of the market share. There is definitely a room for consolidation and the government should encourage the process.”

However, ensuring quality is a potential downside, with some local producers saying they wouldn’t risk distributing other firms’ merchandise because of the risks posed by low-quality products, as well as those from counterfeits. Indeed, due to the prevalence of counterfeit pharmaceuticals in Indonesia, the country has made it onto the US Trade Representative’s (USTR) Special 301 Priority Watch List.

IP & FDI: For potential foreign investors, a lack of patent protection constitutes a huge impediment to entering the market. Furthermore, the continued sale of counterfeits represents a major risk for profit loss and brand image damage. A lack of adequate IP protection, paired with joint venture mandates, make the situation even more challenging.

ENFORCEMENT: The lack of IP rights enforcement has been a serious challenge for Indonesia’s pharmaceuticals industry. Although the country is a signatory to the World Trade Organisation’s (WTO) Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPs), IP enforcement on the ground is often found to be lacking. Governmental reform efforts in this sphere include new regulations that extend the term of patent protection from 14 to 20 years and place the burden of proof on defendants in IP infringement cases.

Still, in a 2010 Special 301 Submission to the USTR, pharmaceuticals companies operating in Indonesia expressed unease about weak counterfeit enforcement, as well as other issues, including halal labelling regulations, Indonesia’s Health Law, the Ministerial Decree 1010 and a lack of compliance with international best practices in processing the procedures for proper drug registration.

With all these obstacles in full view, it is not surprising that foreign pharmaceuticals firms might be hesitant to dip their toes into Indonesia’s drugs industry. This combined with the lack of IP rights enforcement combines to limit foreign direct investment (FDI) in the sector, despite a huge and potentially highly-lucrative customer base. This situation is in some ways an intended consequence of a government policy, however.

INVESTMENT: Another area for improvement remains FDI. While the government works to support domestic pharmaceuticals, at the same time it has restricted FDI by limiting foreign shareholding in manufacturing. Santiago Garcia, president director of Anugerah Pharmindo Lestari, a leading local pharmaceuticals distribution company, argues government stances on FDI are harmful. “The industry’s fundamentals are very solid. With increasing life expectancy, growing population and an emerging middle class, the future looks bright,” he said. “However, the main challenge is protectionist measures set by the government. These have pushed many foreign players out of the industry, harming new potential investor confidence.” This sentiment is shared by others in the industry as well. “There is clearly an interest from foreign companies to tap in the pharmaceutical market, but they are sceptical about stepping in, as the investment environment is not favourable yet,” Novo Nordisk’s general manager, Sandeep Sur, said to OBG.

LOCAL REGULATIONS: Indonesia has put into place regulations requiring pharmaceuticals companies to produce locally, thereby reducing the impact of relaxed tariffs within ASEAN. Recent regulations require local production for at least five years after patents expire. This poses a particular difficulty for foreign companies, many without local manufacturing facilities, and for whom technology to produce their products does not yet exist in Indonesia.

Puspo Sumadi, country manager at Eli Lilly Indonesia, told OBG, “In Indonesia, the regulation requests foreign companies to produce locally if they want to register their products. How are we supposed to distribute our products with our brand if we don’t have a manufacturing unit in the country?”

Novo Nordisk’s Sur concurs with this sentiment. “As a distributor, we are not willing to start manufacturing here now: the costs of manufacturing are too high and even though the market is expanding rapidly, it is still too small.”

However, the government had its reasons for the decree, according to Bahana’s Harry Su. “When you come to Indonesia, you have to establish a manufacturing base. People who come here should try to help the unemployment problem. That is what the government is driving at: to set up labour-intensive companies to help Indonesians get jobs.”

This approach can be problematic for companies wishing to do any research and development (R&D) in the country, especially when it comes to IP rights issues. “For research, we should have 100% ownership to protect our products and avoid them being registered by local companies,” Novartis’ president director of Luthfi Mardiansyah, told OBG.

LONG-TERM: Whether this strategy will succeed in building a domestic sector in the long term is another issue. “Indonesian companies only produce off-patent branded drugs,” Su said. “When you see R&D, it is only 1-2% of sales. They all just wait until it’s off-patent, and then they form their own brands. They are more a packaging company than anything else.” For Indonesia’s pharmaceuticals sector to become an FDI destination, fundamentals such as transparent and stable regulatory and IP frameworks, skilled talent, the ability of companies to hire experts from abroad and increased investment in infrastructure will have to be prioritised. Balancing domestic and foreign companies operating will ultimately have benefits for consumers as well as sector investors.