By Bruce Einhorn At a time when oil prices are soaring because of war fears, deflation may not seem like a pressing concern. Motorists worldwide who are seeing their gasoline bills jump no doubt would welcome news about falling prices. Yet here in Asia, Hong Kong and Japan have been stuck in deflationary ruts for several years, with no end in sight. Moreover, some economists even fear that the other countries are in danger, too, and the fallout could extend to the U.S.
As people debate the causes of global deflationary pressure, many look to China, which has so much overcapacity that companies end up exporting the country's deflation problems. In industries such as consumer electronics, Chinese companies have been ruining profit margins for overseas rivals.
Now, that's threatening to happen for other products. Chinese manufacturers are adding huge amounts of production capacity for cell phones. The same holds true for semiconductors. While China is the world's biggest country and fastest-growing major economy, even consumers in the Middle Kingdom can't digest all that capacity. That means many Chinese companies have no choice but to sell to the rest of the world, and their low prices put deflationary pressure on other manufacturers.
BEYOND GENERICS. A similar dynamic is at work in another Asia giant, India, where drugmakers are suffering from overcapacity at home and hoping to export their way to health. While India today is just a small player in the global pharmaceutical industry, with exports of about $2 billion, the industry is enjoying healthy growth. Companies like Ranbaxy Laboratories and Dr. Reddy's Laboratories are pushing to expand their exports and are increasing their spending on R&D with hopes of becoming more important players worldwide. They're even planning to go beyond sales of generic drugs to launch innovative discoveries of their own (see BW, 3/03/03, "India's Little Drugmakers That Could").
Why the big interest in overseas markets? One reason is that traditional business models for Indian drugmakers won't work much longer. For years, they've thrived by reverse-engineering drugs developed in other countries. That has been legal in India. But starting in 2005, the government has pledged to enforce tougher laws to protect the intellectual property of foreign drugmakers.
Indian companies have have another reason for setting their sights on foreign markets, however: tremendous overcapacity in the domestic pharmaceutical industry. The country has 8,000 drugmakers, of which some 300 are major companies, according to the Organization of Pharmaceutical Producers of India (OPPI), the leading industry group. "Our home base is a very aggressive market," says Brian Tempest, president of pharmaceuticals at Ranbaxy. "For every molecule, there are about 200 brands. There is very, very intense competition."
CHEAP PHDs. Hence, Indian drugmakers suffer from severe deflationary pressure at home. Because of that intense competition, "you cannot increase prices," says Ajit Dangi, the director general of OPPI in Bombay. The domestic market grew 8.5% last year, but that's all because of volume growth, says Dangi. "There's no value growth," he adds.
Another reason why India may start exporting drug-price deflation is the low cost of labor. Of course, China also has an abundance of cheap workers, which is one reason that Chinese hardware manufacturers can afford to sell their products for so little. When it comes to the pharmaceutical industry, though, India's significant cheap labor isn't a big pool of factory workers but a huge crop of scientists.
"The cost of doing research in terms of infrastructure and people is significantly lower than the rest of the world," says G.V. Prasad, chief executive officer and executive vice-chairman of Dr. Reddy's, India's second-largest drugmaker. "If you take a starting PhD in India from a good institute, the cost would be $15,000 to $20,000 or so. In the U.S., the cost would be $70,000."
BIG OBSTACLES. Again, overcapacity is an important factor. Just as India has an abundance of pharmaceutical companies capable of producing medicines, it also has a large population of talented workers. "I could hire 100 scientists in a year without a great deal of effort," boasts Prasad. "To do something like that in the U.S. is very difficult." In the States, he says, "the whole market is much more competitive for talent, the opportunities are much more. To scale recruitment [there] is not easy."
While Indians are optimistic that their pharmaceutical industry is going to follow the example of the country's software companies in leading to high-tech glory, it's important to remember that the local business is still tiny in global terms and faces many big obstacles. Major American and European companies can earn $1 billion in annual sales from one blockbuster drug, more than any one Indian company makes from all its drugs put together. No Indian drugmaker approaches the multibillion-sales figures of a Merck (MRK), Pfizer (PFE), or Novartis (NVS), and the Indians can spend just a fraction of what the big players pour into R&D to produce innovative drugs.
Compared to the electronics or software industries, the pharmaceutical business is also highly regulated by bureaucrats at the U.S. Food & Drug Administration and other government agencies worldwide, making it much harder for an Asian newcomer. So it's highly unlikely that Indians will do to the drug industry what the Chinese have done to things like DVD players and TVs.
Still, it would be shortsighted to dismiss the Indians as insignificant. Yes, when it comes to developing their own drugs, they can't compare to the big Western pharma companies. But look at the electronics industry and the experience of the Taiwanese and, increasingly, the Chinese. Most of their contract manufacturers and designers aren't innovators either, yet that hasn't stopped Greater China from becoming one of the electronics industry's most important centers. As India's companies become more successful selling low-cost generic drugs and ingredients overseas, they have a chance to fill a similar niche. Einhorn covers technology from Hong Kong for BusinessWeek. Follow his weekly Online Asia column, only on BusinessWeek Online