Emerging Markets:The Myths and Traps

Over the next five years, nearly two-thirds of pharmaceutical sales growth is forecast to come from emerging markets. This represents about $150 billion in new revenues and will raise the share of pharmaceutical sales from emerging markets to close to 30 percent of the global total. Sales generated from new products are not sufficient to replace sales from products losing patent protection, hence expansion into emerging markets would seem to be a logical part of any company's long-term growth strategy.

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Most major pharma players are vying for leadership in this faster-growing part of the "two-speed world." As they scale back costs in developed markets, companies are building R&D, manufacturing, and sales force capacity in emerging markets, with a particular emphasis on China and India.

While the optimism of straight-line forecasts for emerging markets sales growth may be debatable, there is clearly a sizeable prize to be captured. But emerging markets represent a competitive game—and playing that game successfully is far from straightforward. Based on our experience with global pharmaceutical companies and multinationals in other industries, there are important distinctions to be made between "profitable early-stage participation" and "winning the end game"—and between knowing what to do and doing it better and faster than competitors. Furthermore, not all emerging markets are created equal, and while some global pharmaceutical companies have found ways to win in particular emerging markets, few are winning consistently across a majority of markets and sub-segments.

Players have an opportunity to increase their long-term performance by recognizing and avoiding a common set of pitfalls and mental traps. But what will distinguish the real winners is the clear-headed application of fundamental business strategy principles to prioritize investments and guide decision-making. Specifically, what are these myths and mental traps and what strategy imperatives will differentiate the winners from the also-rans?

Marking the Markets: Myths and Traps

In the race to find additional sources of profitable growth, players sometimes underestimate the challenge of building sustainable competitive advantage in emerging markets. While some pitfalls in strategic approach and operational execution may seem obvious from afar, they are often hard to avoid in the throes of competition.

Myth: "Globalization" is a constant and a given. The prospects for emerging markets hinge on the interconnectivity of the world economy. As ubiquitous as the term globalization is, it is not necessarily a smooth, predictable, and irreversible trend. Growth predictions must not be seen as inevitabilities; instead, companies should monitor and manage economic and political risk, prepare for a range of scenarios, and proactively shape the political environment.

Myth: Bad Industrial Policy precedents can be contained. Governments in emerging markets are aware of their increasing influence, and some employ a range of measures to tilt the playing field in favor of domestic pharmaceutical companies. For example, in June, Vietnam's Ministry of Health requested that the Ministry of Trade exempt local pharmaceutical companies from an import tax on a key manufacturing ingredient in an attempt to stabilize the domestic market. Similar dynamics are playing out in other countries too.

More broadly, the loosening of intellectual property protections is a significant risk factor for profitable growth in emerging markets. For example, when Brazil invoked compulsory licensing in 2007 to allow domestic players to produce and sell a low-cost version of Merck's antiretroviral Sustiva, then-President Luiz Inácio Lula da Silva, spelled out the rationale in plain terms. "Between our trade and our health," he said, "we have chosen to look after our health." Understanding the nuances and implications of shifting local market regulatory conditions is therefore critical to emerging markets success.

Myth: All emerging markets are created equal. While this myth seems obvious, there are still some players who, by applying a one-size-fits-all approach, overlook the extreme socioeconomic and geographic differences between emerging markets. Among the BRIC countries, Russia has the highest GDP per capita, at about $15,000, while nearly three in four people live in cities. At the other extreme, India has the lowest GDP per capita relative to the other BRICs, and although it is the most densely populated, at nearly 370 people per square kilometer, only three in 10 people live in urban areas.

Unmet medical need varies by market, as well. In Russia, the greatest disease burden—as measured in disability-adjusted life years (DALYs)—is from cardiovascular and metabolic disorders, while in India, the most significant burden is infectious disease. In Brazil, China, and Mexico, neuropsychiatric disorders have the greatest burden on healthcare costs. These distinctions have important implications for the products that pharmaceutical companies need to bring to market, as well as the ways that they connect with physicians and patients.

Health practice in each country is also characterized by a unique mix of channels, such as OTC, generics, tender, government, private, and hospitals. Investors must think about tailoring the model to each market and even about operating multiple models within individual markets. For example, in Russia this could mean focusing one unit on the out-of-pocket segment and another on state-funded healthcare. The business model requirements are different for each: the out-of-pocket segment needs a business model much closer to that of a fast-moving consumer goods business, one where knowing the mind of the customer is critical, while dealing with the state-funded health system requires regulatory know-how, government-relations capabilities, and strong payer negotiation skills.

Myth: We can apply our traditional business models to emerging markets. Companies have typically entered emerging markets, starting with high-end, premium-priced urban segments, where variants on their core commercial model can be deployed. Companies which do not transcend their core Western business models frequently fail to capture the long-term growth they expect because they neglect the lower demographic tiers, secondary channels, and market specificities which can account for the bulk of the market. The patent protections, global manufacturing scale, and marketing horsepower that serve as drivers and competitive differentiators in the West may not be sufficient in emerging markets, where the lines between innovative pharmaceuticals, generics, and over-the-counter products are often less distinct. This also makes establishing local cost effectiveness much more critical. Winning requires bold life-cycle management, low-cost local manufacturing capacity or partnerships, and strong regulatory stakeholder management. Fundamentally, companies need to embrace the necessity of business model innovation in emerging markets.

China alone has over 150 cities with a population greater than 1 million. Many of the top multinational pharmaceutical players in China get the vast majority of their revenues from the top 30 cities. But building for the long term requires not just going to the next set of cities—they are already there—but capturing the larger impact as the next billion consumers beyond the top of the pyramid work their way into the healthcare system. We see that current medical rep-intensive approaches beyond the top cities are already proving to be much less profitable due to dramatically lower rep productivities from smaller accounts, higher price sensitivities, and less-efficient logistics. Instead, companies must think through different business models that can keep in touch with doctors and influence prescribing behavior but at much lower cost.

Myth: We don't need to worry about local competitors. Local incumbents are smaller than their multinational competitors and generally have inferior capabilities in areas such as R&D. Yet many local competitors grew up in the generics sector and are defending their home turf effectively against large multinational players. In fact, while many multinationals trumpet relatively high growth rates in emerging markets compared to core developed markets, they are generally growing slower than these markets overall and are losing share to local players. Local players continue to displace global pharmaceutical players, especially in state-run auctions for products without patent exclusivity. These local players can source API from India and China and manufacture and package locally at considerably lower cost. Furthermore, if we look at the evolution of other industries, where low-cost local players have emerged over time as regional or global leaders, it would be a mistake to exclude local competitors from serious consideration.

To give one example: While multinationals lead the Mexican market in absolute local sales, the five fastest-growing companies are all local players. Locals can also provide key partnership opportunities, enabling multinationals to learn the nuances of markets and to access workable models for mass-market segments.

Myth: We won't face the access and trust challenges we face in developed markets. Many players have pursued a very aggressive commercial model in emerging markets, which seems to be predicated on the assumption that access and cost control challenges, which have increasingly constrained their businesses in Western markets, will not be an important factor. In fact, access is shaping up to be at least as important in emerging markets. While China has an attractive, growing segment of wealthy urban patients who are either insured or willing to pay out-of-pocket for innovative pharmaceuticals, most patients are served through China's basic healthcare system.

As part of this system, reimbursement lists and price caps are set by central bodies, but can be adjusted at the provincial level. And at the local level—an expanse that includes about 10,000 hospitals and clinics—local reimbursement policies are used to control the usage rates of top-selling drugs. It's not an easy course to navigate, and success requires multinational pharmaceutical players to negotiate a complex tendering process with each hospital. Price controls can also have a significant impact on the attractiveness of the opportunity. China's National Essential Drugs List caps the prices of about 300 drugs and India is following suit by revising its National List of Essential Medicines to include about 300 bulk drugs and nearly 600 related formulations under government price control. It is therefore advisable to test growth plans for robustness at low equilibrium price points and to consider the parameters of business models which would be profitable even at the low end of plausible prices.

Global pharmaceutical companies should also prepare to face intense scrutiny over product quality and authenticity. This increases the importance of choosing local partners wisely and managing supply chains tightly, to protect precious corporate reputations and trust. Thus, penetrating emerging markets requires sophisticated, on-the-ground knowledge and investment in science policy, pharmacoeconomics, healthcare policy, corporate responsibility, and other capabilities to ensure that players emerge as trusted insiders, contributing to national health priorities, with accessible offerings and undisputed value.

Myth: Emerging markets can be run effectively from Western headquarters. As emerging markets have risen in strategic visibility and priority, there has been a shift in the management model from a relatively hands-off approach for a heterogeneous portfolio of markets, to a more deliberate and centralized model. But given the specificities of each market, their rapid rates of evolution, the intrinsic ambiguity and uncertainty of their development, and also the importance of the political dimension, the pendulum may have swung too far.

To build a viable presence in these countries, multinationals must have a well-defined approach for identifying, developing, and retaining local talent, reinforced selectively with expatriate appointments. Some pharmaceutical companies treat emerging markets' management roles as short-term leadership developmental opportunities. While these rapidly changing markets may indeed be an effective leadership development laboratory and the excitement of an 18-month international posting is an effective talent retention tool, if companies are serious about establishing a long-term presence, they must systematically attract and integrate top-notch local management talent and take a longer-term view.

It is also important to establish longevity in local market relationships. It takes time to build the same level of relationships and credibility with regulators and customers that local pharmaceutical companies have worked for decades to establish. It also takes local knowledge to identify whether partners are needed, and if so, which ones are the right ones. Many local emerging markets' pharmaceutical players are family-owned, have a long history of operations, and compete with multinationals for top local management talent.

Finally, pharmaceutical market data providers do not provide audited data for the entire market and, in some cases, overlook major rapidly growing market segments. For instance, in Mexico, Walmart purchases significant volumes from local generics players. Such elements are not reflected in widely accepted market data. These insights are easy to miss without a sophisticated on-the-ground presence and knowledge of market dynamics.

Strategy: The Four Fundamentals

All global pharmaceutical players understand the economic opportunity in emerging markets. And while many may have already recognized the dangers of the myths and mental traps described above, few have succeeded in putting this knowledge to use in developing a competitively advantaged strategy and suite of innovative business models in emerging markets. Yet it is the consistent application of a set of strategy fundamentals that really make the difference in positive engagement that drives long-term profitability. Such strategy fundamentals comprise the following:

Seek out value, not just growth. Long-term price points are, or could conceivably become, very low in some countries, channels, and segments. Revenue growth has been a good surrogate for value creation in the West, but unprofitable growth is entirely plausible for some emerging markets, especially if current developed country business models and cost structures are assumed. Therefore, companies need to think about which countries, segments, and channels they will participate in and measure value creation segment by segment as well as by top-line growth.

Don't neglect the innovation agenda. To win in emerging markets, global companies must innovate on the frontlines, rather than rely on standardized business models dictated by headquarters. Often, however, they do not have the capabilities in place to drive business-model innovation locally. Global pharmaceutical companies risk missing not only the opportunity to serve the growing middle-market segments of emerging markets, but also the opportunity to originate disruptive new business models, which may be later exportable back to core developed markets.

Develop a more adaptive and dynamic approach to strategy and operations. Turbulence and unpredictability have increased, undermining the effectiveness of traditional episodic and top-down approaches to planning, and also shifting the basis of competition from scale, positioning, and efficiency to adaptability. Emerging pharmaceutical markets provide an extreme example of this phenomenon. An approach that emphasizes experimentation and rapid iteration is necessary in order to keep pace with incessant change. Four competitive attributes ("The Four Rs") are essential for adapting effectively in a rapidly changing environment:

» Readiness: the anticipation of changes.

» Resilience: of plans to unanticipated market shifts.

» Responsiveness: rapidly responding to and taking advantage of changes.

» Recursion: rapidly and continuously learning how to do new things.

This requires a very different approach to organization, which emphasizes risk-taking, decentralization, challenging prevailing wisdoms, flexibility, and rapid mobilization. It also requires a different approach to leadership, whereby leaders set the context for learning, rather than dictating a static instruction set.

Don't lose sight of the change imperative in the core business. The challenges facing the current pharmaceutical industry model run deep. Consider that in 2000, the 20 largest biopharma companies had a market value of $2.2 trillion. By 2010, their value had dropped to $1.5 trillion. Granted, the Dow Jones index was flat and the S&P lost 10 percent—but the decline of the pharmaceutical industry's market value, at 32 percent, was particularly sharp.

The collapse of the industry's P/E multiple reveals a lack of faith in the ability of pharmaceutical companies to sustain their performance.

Emerging market participation is no panacea, but they do offer an opportunity for a different type of innovation. Industry leaders should ask themselves how many cents of each R&D dollar should be spent on non-product innovation and make sure they are seizing the opportunities for business model innovation which emerging markets present.

The prize of emerging markets is a valuable one. But competitive leadership should not be confused with profitable participation. The winners will be the ones who embrace anomaly and change in emerging markets with agile, innovative organizations and new, powerful business models.

Martin Reeves leads Boston Consulting Group's Strategy Institute and is a Senior Partner in New York. John Wong leads healthcare for BCG in Asia and is a Senior Partner in the firm's Hong Kong Office. Ethan Dabbs is a Principal in BCG's New York office.