When Dr Reddy’s Laboratories—India’s second-largest drug maker by sales—crossed the billion-dollar turnover mark in 2006, its founder Dr Kallam Anji Reddy wrote a letter to his colleagues thanking them for their dedication. He shared his ambition for the company he had founded in 1984, and wrote how he wanted Dr Reddy’s to become the first Indian company to discover a drug or a chemical.
Drug Discovery a Pipedream?
As someone who was with Anji Reddy during the company’s drug discovery phase in the 1990s, Satish has seen the R&D challenges up close. He insists that Dr Reddy’s has not changed, merely evolved. The drug maker hasn’t quite given up on innovation altogether; it is just adopting a practical approach about it. “The core of the company remains intact,” he says.
Even under his father, the company bore many costly failures: In the 1990s, it was trying to discover its own patentable drugs, but none of those made it to the market. Anji Reddy was unable to sustain his dreams on passion alone, and during his tenure, the company had to close down drug discovery programmes in diabetes and cardiovascular diseases. For instance, it shut down R&D on a Type-2 diabetes molecule after nine years of research.
Investor concerns over such failures forced the management to go slow on its drug discovery programme. “In 2005-06, our R&D spend was 14 percent of our sales,” says Satish. “A significant portion of it went into drug discovery and it was unmanageable.” Finally, in 2009, Dr Reddy’s merged its drug discovery unit in Hyderabad with a subsidiary, Aurigene Discovery Technologies Ltd, a biotech firm based out of Bengaluru. The aim was to cut down on research cost. Today, drug discovery is being pursued through Aurigene, which focuses on collaborative research and out-licencing deals with foreign pharmaceutical companies in areas of oncology, anti-inflammatory drugs and anti-infectives. (Dr Reddy’s does not fund Aurigene; it functions as a separate entity.)
In out-licencing deals, the licensor transfers intellectual property rights to a third party for a fixed duration. It can take years, sometimes more than a decade, for a drug to reach the market. During this period, companies don’t make any revenue to offset their R&D costs. Pharmaceutical companies like Dr Reddy’s licence out molecules to global drug companies after reaching a certain stage of development to reduce R&D cost and generate revenue.
The lack of a conducive climate for drug discovery is a stumbling block as well. “In India, there is no environment for moving up the value chain,” says Satish, referring to a lack of funding and support from government institutions. Unlike in the US, where universities help in drug discovery, the Indian academia is not much involved.
Besides, when it was on the path to drug discovery, Dr Reddy’s struggled with animal clinical trials in India. “We had to do it in the Netherlands at 10 times the cost because there were all kinds of regulations that prevented us from doing it in India,” says Satish.
Frost & Sullivan’s Singh says drug discovery is an expensive passion to pursue. “It takes $800 million to bring a new drug to the market. Considering the entire Indian pharmaceutical industry spends only $1 billion on R&D annually, it is foolhardy to assume that drug discovery will take off in India.”
It is little wonder, then, that Anji Reddy’s successors prefer the tried and tested, and more practical, generic drug model. Today, 81 percent of Dr Reddy’s revenues come from generics. “What is wrong in being a generic company?” asks Prasad. “We create a lot of value for patients. If we can serve good health, it is enough for us.”
R&D of the Proprietary Kind
This doesn’t mean that the pharmaceutical company has jettisoned all innovation that will take place through proprietary or branded drugs. Unlike new drugs that require new molecules, proprietary brands are made from known molecules. It is less risky and time-consuming than drug discovery. “We are doing innovation and not drug discovery, so our proprietary products business is our answer to your question on innovation,” says Prasad.
Dr Reddy’s currently has 18 proprietary products under development and three new drug applications (NDAs) to market new formulations of existing drugs with the US Food and Drug Administration. These three drugs are for the treatment of dermatological and neurological ailments. “Proprietary products business helps us in improving outcomes by identifying their unmet patient needs and addressing them through innovative and affordable products,” says Prasad.
The company has said it will invest about $320 million over the next three years to develop its portfolio of proprietary products and biosimilars (follow-on versions of original biological medicines). In FY15, it spent Rs 1,745 crore or 11.8 percent of its revenue on R&D, of which 40 percent went towards proprietary products and biosimilars. The rest went towards developing generics.
Since developing proprietary drugs is time-consuming, expensive and risky (although less risky than new drug discovery), the increased expenditure on proprietary medicines did invite criticism from a section of analysts who felt it diluted the company’s RoC (return on capital). Prasad shrugs off the criticism. “It depends on what your time horizon is. If you are going to look at a one-year horizon, every dollar spent on R&D is RoC-dilutive. If you look at a decade, it will be accretive. In the long term, innovation always adds value.”
Satish, too, is leaning on proprietary drugs to take Dr Reddy’s to the next level. “Here, chances of success are much greater than doing drug discovery,” he says. He heads the Indian Pharmaceutical Alliance which represents large domestic drug makers, and wants to create an ecosystem that will encourage innovation. “The question of how do we move up the value chain is not even being asked,” he says. “We are more worried about price control and regulation.” For now, though, he sees proprietary drugs as an exciting game for Dr Reddy’s.
Growing Through Partnerships
For Dr Reddy’s to remain competitive, it will have to move towards complex generic drugs (the basic generic space is highly competitive already). It is no coincidence that the company’s revenue contribution from complex generic products has steadily increased to 57 percent in FY2015 from 29 percent in FY2012. If Satish and Prasad play their cards right, a hefty percentage of Dr Reddy’s future revenue will come through complex generics or non-patented drugs that may involve complex active pharmaceutical ingredients (or APIs, key ingredients that help make a drug effective).
Dr Reddy’s has complex generic drugs in the areas of injectables, patches, eye-drops and topical medications. Typically, it partners with drug makers in the US and Europe to co-develop products in areas where it does not have in-house competency.
In the past, it has partnered with foreign companies like Galena Biopharma, Merck Serono and GlaxoSmithKline to develop products in fields like oncology, cardiovascular diseases, diabetes and gastroenterology. “If we feel a particular area is large enough, we build our own competency in terms of manufacturing and R&D,” says Prasad.
A case in point is the injectables drugs business in the US where Dr Reddy’s partnered with several injectables drug companies before venturing out on its own.
Dr Reddy’s had also acquired OctoPlus, the Netherlands-based injectables company in February 2013 to strengthen this part of the business. It has since scaled up its US injectables business to $280 million from $60-65 million three years ago.
The drug maker is now mulling partnerships in the areas of neurology and dermatology. Mukherjee calls partnerships a necessity. “We were alright by ourselves, and we would have gotten there (complex generic drug development) but that would have taken till 2020.”
Expanding Through Acquisitions
Now that it has a blueprint of its future in place, the next step is expansion. “We are aggressively looking at acquisitions,” says Prasad. His brother-in-law agrees. “You might ask us why didn’t you do this four years back but that was the time when we had to get operations in order and strengthen a lot of things,” says Satish.
It is not a statement that one expects to hear from Dr Reddy’s, which, when compared with its competitor and market leader Sun Pharmaceuticals, has been quite conservative about inorganic growth. But the status quo has changed. “We are no longer conservative about acquisitions,” says Dr Reddy’s chief financial officer, Saumen Chakraborty. It helps that the company has zero debt and enough ability to raise money for acquisitions. “We have surplus cash, so our net debt is negative. It was 0.03 as of March 2015,” he says. The company is open to making acquisitions up to $1 billion.
Satish is quick to clarify that the drug maker will not acquire companies just to grow in size. “Acquisitions will be for value creation and certainly not for size enhancement. There has to be a very clear strategic rationale for each and every acquisition we do,” he says.
Dr Reddy’s is looking to acquire branded businesses in emerging markets similar to the UCB acquisition it made in India. (In June this year, it acquired for $128.38 million select brands of Belgian drug maker UCB SA in the markets of India, Nepal, Sri Lanka and Maldives. The move is aimed at expanding into respiratory, dermatology and pediatrics drugs.) “We might even look at a large acquisition if it helps build the company’s presence and critical mass.
Let us see,” says Prasad. It could even acquire companies that give it access to new technology or it could use the acquisition route to enter new markets in Europe, besides the UK and Germany, and South America.
While Satish agrees with Prasad on the topic of acquisitions and their role in the drug maker’s growth, he says his work at Dr Reddy’s is limited. “Except for being on the board, I don’t spend much time on the company,” says Satish. Instead, he works on his passion for corporate social responsibility (CSR), which he inherited from his father.
In 1996, Anji Reddy had set up Dr Reddy’s Foundation in Hyderabad to focus on CSR initiatives. Satish is the chairman of the foundation, which works on livelihood, education and health care related issues across 10 states, including Andhra Pradesh, Bihar, Karnataka and Jharkhand. He is also a trustee of the Hyderabad-based public charitable trust, the Naandi Foundation, which is present in 14 states.
Satish speaks animatedly about his philanthropy work and the CSR initiatives undertaken by Dr Reddy’s Foundation. He talks about the pilot project where the Foundation is training community workers to improve the delivery of primary health care to villagers. It is a change from being the COO, a post he previously held between 1995 and 2014. “Do I enjoy this more? It is difficult to say because I am more passionate about the CSR work, but I do miss the day-to-day excitement of running the company,” says Satish.
For now, though, he and Prasad hope to keep Dr Anji Reddy’s legacy alive through innovation.
(This story appears in the 29 October, 2015 issue of Forbes India. To visit our Archives, click here.)