This end of year panoramastarts with the risk assess-ment of 14 sectors in thethree regions we monitor.North America is witness-ing major evolutions. Ourassessments in this region

are improving for chemicals, transporta-tion and textile-clothing. These threesectors are benefiting from the goodshape of the American economy andfrom the fall in oil prices. This drop is particularly helping US airline compa-nies, who are reaping the fruits of theirefforts to restructure their activities and

By Coface Group Economists

improve their margins. North Americanchemical companies are gaining advan-tages through their access to non-con-ventional oil and gas, and through theupward trend in the activities of theirmain customers (automotive, construc-tion). Lastly, the textile-clothing sector isbeing strengthened by the dynamics inemployment and household consump-tion. The sudden drop in oil prices con-stitutes one of the major changes sinceour last publication. This will give a boostto sectors such as chemicals, but willhave a negative effect for oil producersand contractors.

The following study focuses on the phar-maceuticals sector in Western Europe,which is experiencing a constraint indrug sales. Pharmaceutical companieshave many hurdles to overcome, such asthe restrictions in health spending,mainly due to the economic crisis, andstate regulation of their activities. Onequestion remains: is austerity lethal forthis sector? We will see that this sectorcan grasp growth from the emergingcountries, as well as growth generatedby innovation in complex therapeuticareas such as oncology, diabetes andcardiovascular illnesses.

T

PANORAMASECTORSTHE COFACE ECONOMIC PUBLICATIONS

November 2014

2Sector barometer

9Study : European pharma-ceutical companies: is austerity fatal?

+Has the pharmaceutical 9sector suffered from the economic crises?

+New shocks 11to absorb

Why is austerity 13not fatal

ALL THE OTHER GROUP PANORAMAS ARE AVAILABLE ONhttp://www.coface.com/News-Publications/Publications

2

NOVEMBER 2014

SECTOR BAROMETERBY OUR ECONOMISTS

SECTORSPANORAMA

GROUP

Khalid AIT YAHIAEconomist

Guillaume BAQUEEconomist

(1) Hausse de +0,8% seulement (source : CPB).(2) Source : OCDE (dernière année disponible : 2011).

weak recovery requires Coface to keepits sector risk assessments unchangedfor this region. And, in emerging Asia,the sectors linked to infrastructure inChina are continuing to suffer fromovercapacity (metallurgy, chemicalsand construction). Against this, theautomotive, distribution and services

sectors are still benefiting from the riseof the middle class and increasedhousehold consumption. You will findbelow a table summarising Coface'ssector risk assessments, followed by adetailed analysis of 6 sectors.

Coface is upgrading its risk assess-ments for the chemicals, transportationand textile-clothing sectors in NorthAmerica. Apart from the still favourablegrowth prospects in the United States,these sectors benefit from the markeddecline in the prices of raw materials.From a European perspective, the

« Coface is upgrading its riskassessments for the chemicals,transportation and textile-clothingsectors in North America »

SECTORIAL RISK ASSESSMENT

Sectors Western Europe* Emerging Asia North America

Agro-food � � �

Automotives � � �

Chemicals � � �Ï

Construction � � �

Electronics, IT ** � � �

Energy � � �

Engineering � � �

Metals � � �

Paper-Wood � � �

Pharmaceuticals � � �

Retail � � �

Services � � �

Textile-clothing � � �Ï

Transportation � � �Ï

Sources : Datastream, Coface

* See credit risk chart page 8** Electronics, information technology and telecoms

� Moderate risk � Meduim risk � High risk � Very high risk

remain below pre-crisis levels in a context ofslightly lower public investment and relatively highhousehold debt.

We are reassessing the North Americanchemicals sector to moderate risk, as it isfully benefiting from the competitivenessgains due to lower production costs andbecause its customers are benefiting fromthe healthy economic situation.

Western Europe Manufacturing activity in the Eurozone has notsucceeded in recovering, posting a fall of -1.9%over one year in August 2014. Industrial activityremains at half-mast in Italy and France. It alsoslowed this summer in Germany (-4.3%) due tothe Russian-Ukrainian crisis and temporary sea-sonal factors. However, although these elementsdo not look very promising, the fall in oil pricesgives a boost to companies in the chemicals sec-tor, as naphtha prices are also down – somethingthat will reduce the competitiveness gap withNorth American rivals.

The level of risk remains high.

Emerging Asia Manufacturing activity will benefit from the slightacceleration in world growth this year, though the summer’s disappointments from Europe arehitting the most exposed economies in theregion,(such as Korea where business confidencewas down for the second consecutive month inOctober 2014). However, the signs from India arepositive. Manufacturing activity is still in theregion of expansion, above the mean (51.6).Finally, the sector’s prospects are still mixed inChina, where some segments such as PVC (whichhas been badly affected by a slowdown in con-struction), are increasing their share for export.

We are keeping the risk level as high for this region.

3SECTORSPANORAMA

GROUP

CHEMICALS

Sector trends are mixed, depending on regions.North America is performing well and, moreover, hasbecome the preferred country for many players inthe sector. As for Western Europe, it is still stuck in asluggish recovery, which is weakening the sector.However, the fall in crude oil prices, if it lasts, will actas a stimulus by slightly lowering production costs.Finally, the sectors’ players in emerging Asia remainweak, although some are looking beyond their ownfrontiers in order to capture value.

North America Industrial production in the United States grew3.2% at the end of Q3 2014, compared with thesame period in 2013. Sales of automotives are alsodoing well (up by 1.4% over the first ten monthsof the year, compared with 2013), in a context ofsustained household consumption. As for con-struction, activity and prices are rising, but they

1

Industrial production (index, 100 = Jan 2007)

Source : National statistics institutes

110

100

90

80

2007 2008 2009 2010 2011 2012 2013 2014

Eurozone France

United StatesUnited Kingdom

Germany

ELECTRONICS, IT

World smartphone sales remain strong thanks to theemerging countries. Sales of tablets are growingmore slowly than in 2013, while computer sales con-tinue to fall - though less sharply than in previousyears. The software industry is reporting a growthin financial results, particularly in the United States.According to IDC, software sales are expected to riseby 6% compared with 2013.

North America Tablet sales are sharply up (+18% at the end ofSeptember 2014, over 12 months). This is partlyexplained by sales to schools and also by theattraction of consumers to low-cost tabletsaccording to IDC. The software industry is record-ing good results, thanks to the move towardscloud computing. Healthy American growth and

2

Emerging Asia Smartphone sales were up by 25% year-on-yearat the end of September 2014. Chinese and Indianmanufacturers are developing the low-cost seg-ment, with a good presence in the rest of SouthEast Asia, as well as in the Middle East and Africa.Computer sales, for their part, are stabilising afterfalling for several years. The Chinese and Tai-wanese groups have managed to keep or evenincrease their market share, to the detriment oftheir American competitors. Profitability for thesector as a whole was up 3.9% year-on-year atthe end of September 2014.

The risk remains medium.

Western Europe The situation remains difficult in Western Europein the face of sluggish demand. Growth and jobprospects for France (expected growth +0.4% in2014 according to Coface) and Italy (-0.2%) areweak, while German growth has been reviseddownwards. Accordingly the sector’s turnoverwas down 1.8% year-on-year in September 2014.

The risk remains high in the short term.

4 SECTORSPANORAMA

GROUP

falling unemployment, together with updatedproducts, are further explanations for this growth.However, this economic dynamism is not posi-tively impacting American wages.

We are not changing our assessment of the risk, which is medium.

Private consumption

(%, year on year)

Source : National statistics institutes

Eurozone France

United KingdomGermany

3

2

1

0

-1

-2

Q12013

Q22013

Q32013

Q42013

Q12014

Q22014

ENERGY

Oil prices have fallen in recent weeks. This suddenfall has affected most players in the oil segment andalso that of gas, since the price of gas is correlatedwith that of oil. The risks will become apparent if

prices remain in the region of $80/barrel, not onlyweakening the oil-related companies but also reduc-ing investment in unconventional hydrocarbons.

North America The major oil companies announced the resultsof their production activity in half tones in Q32014. For our part, we observe a 7% fall in prof-itability year-on-year. The WTI price fell by morethan 25%, to $80 a barrel on 31 October,approaching the break-even level for invest-ments in shale oil. Moreover, because of stronginvestment in recent years, there has been astrong expansion in contracting parties’ supply.Faced with fewer projects in the future, if pricesremain low, the oil-related sector will have excesssupply.

Prospects will depend on changes in WTIprices, as will our risk assessment, whichremains unchanged at the moment.

3

Price of a barrel of oil (USD)

Source : Thomas Reuters

120

115

110

105

100

95

90

85

80

75

01/20

14

02/20

14

03/20

14

04/2014

05/20

14

06/20

14

07/20

14

08/20

14

09/20

14

10/2014

WTIBrent

Western Europe Following the example of the WTI in the UnitedStates, Brent has also fallen since its June peak (-25%), to reach $85/barrel on 31 October. The bigproduction companies are all recording a fall in prof-its for Q3 2104. The refining sector, for its part, is facing overcapacity because of stalling demand.Moreover, competition from new players in thesector is further weakening the refiners. Margins arelow (+/- ¤20/tonne) and the sector’s players areconsequently suffering losses. The fall of Brent, if itlasts, will not be enough to compensate for thosefundamentals which have deteriorated.

The level of risk remains medium.

Emerging Asia The fall in prices has also affected the profits ofAsian national companies. However the risk isgreatest for the refiners, affected by the reductionin subsidies on diesel (India, Indonesia), as well asby stagnant demand for diesel. Effectively, slug-gish demand is leading to falls in production insome countries (South Korea, Japan), in order topreserve refining margins. Exports to Europe arenot enough to make up for the domestic market.As such, the Singapore diesel benchmark of500ppm has fallen by 3% since August.

We are not making any change in our riskassessment.

RETAIL

The situation varies greatly between developed andemerging countries. Effectively, the former are suf-fering from sluggish household consumption. At thesame time, lower food prices, linked to good harvestsand accentuated by the ban on exporting certainprocessed food products (from the EU and theUnited States in particular) are affecting the marginsof some retailers, which are undergoing a prolongedslowdown in their sales. To stem this downturn ingrowth, they are investing in new growth sources,especially in e-commerce. In contrast, the number ofemerging middle-class households continues togrow, which is driving distribution growth in emerg-ing Asia.

Western Europe The price war is at its fiercest in large scale distribu-tion. After eight consecutive quarters of decline,household consumption has been growing again inthe Eurozone since the third quarter of 2013 (+0.8%year on year in Q2 2014). However, purchasingpower remains constrained by weak growth inwages and by unemployment, which still affects11.5% of the population using the common currency.

In this context, the major food retailers are continuingto drive prices down in order to maintain their busi-ness volumes. Accordingly, food prices have beenfalling in the Eurozone since May 2014 (-0.3% in Sep-tember 2014 year on year). The same is true in theUnited Kingdom, where this trend has not beenobserved since October 2004 (1). Although privateconsumption continues to grow (+2.0% year on yearin Q2 2012) and unemployment continues to improve(6% in July 2014), wages are stagnating. Householdsare increasingly turning to hard discount retailers,chiefly from Germany, such as Lidl and Aldi. Althoughstill less than the 11.9% observed in France, their mar-ket share has grown considerably to reach 8%, com-pared with 5% in 2012 (Kantar World panel). Tesco,the UK's top supermarket and No3 in the world afterWalmart and Carrefour, has seen its market valuationhalved since the beginning of the year, linked to inter-nal scandals and three profit warnings in 2014. It isthe same story at Sainsbury’s, the UK's second lead-ing supermarket, which has revised its annual salesforecasts downwards.

The risk remains medium but a prolongedperiod of sluggish household consumptioncould lead to a deterioration.

4

5SECTORSPANORAMA

GROUP

Food price variations

(Average annual %)

Source : Eurostat

6

5

4

3

2

1

0

-1

-2

2010 2011 2012 2013 2014

Eurozone France

United KingdomGermany

(1) Two consecutive months of decline

Emerging Asia The region’s growth remains dynamic at 6.3% in2014, identical to 2013 according to Coface. The sec-tor benefits from the rise of the emerging middleclasses, who are equipping themselves with durablegoods and want to enjoy the same comfort as theirwestern counterparts. The low rate of domesticappliance ownership is an indication of the signifi-cant growth potential of these countries. For exam-ple, only 15% of the rural population in Vietnam hasa washing machine, while half of them have a refrig-erator, which in turn increases the propensity to con-sume fresh products.

In China, the volume of retail sales grew by 11% in2013, as a result of the continued rise in wages. Thisrise of the middle class has resulted, in particular, ina rapid increase in the number of physical shops. In2013, the number of shops increased by 19.1% in Thai-land, by 13.3% in Indonesia and again by 11.9% in India(Euromonitor). Investment in commercial infrastruc-tures, essentially shopping centres, has grown onaverage by 28.5% p.a. since 2009 in China. However,the sector is driven by the growth of e-commerce.For China, this led to a 43% increase in sales in 2013(EIU). The development of smartphones and thedemocratisation of the Internet in rural areas arecatalysing the growth of the sector in emerging Asia.In India, 15% of the population has access to the Inter-net, against 7.5% in 2010 - effectively doubling theconnected population. In the medium term, the mainrisk for the sector lies in the high level of household

debt in some of the region’s countries (Korea,Malaysia, Thailand and Singapore in particular).

In this context of strong growth, the riskremains low in emerging Asia.

North America The environment is hardening for the major retail-ers, despite the fall in unemployment in theUnited States (at 5.9% in September 2014) andsustained private consumption (+2.4% year onyear in Q2 2014). Inequalities are growing andconsumer habits are changing. The world’s num-ber one retailer and biggest employer in theUnited States, Walmart, has therefore lowered itssales growth forecast for 2014. The growth rate isexpected to drop from 3-5% annually, to 2-3%. Inresponse, the distribution giant will considerablyincrease its investment in e-commerce, whichcurrently stands at $1 billion, by 20% to 50%.However, with end-of-year sales representingbetween 20% and 25% of annual turnover forretailers, they are now multiplying promotionsand the prospects are favourable. The fall in oilbarrel prices (which has just reached its lowestpoint since June 2012 at $80) is expected toboost the purchasing and travel power of house-holds, which will be more inclined to increasetheir spending for the end-of-year festivities.

Our risk assessment is therefore still low.

TEXTILE-CLOTHING

Manufacturers in the sector are improving their mar-gins thanks to the fall in the price of raw materials -particularly cotton, which is at its lowest since 2010(at 62 cents a pound for delivery in December). Thisis explained by the abundant supply and the fall inChinese demand. Emerging Asia remains a dynamicarea, but the reduction of duty-free import quotas inChina from 2015 is expected to drive up the cost ofraw materials on this key market. As for the devel-oped economies, the Europeans are again buyingclothing, while in North America the growth of thesector is slowing and seems to be stabilising.

Western Europe After two difficult years, 2014 has been a year ofrecovery. Over the first half of 2014, textile andclothing manufacturers posted a 4% increase intheir activity compared with the same period in2013 (Euratex). The big European economies arebeginning to consume clothing again, with posi-tive sales growth since the beginning of the year.As an illustration, the clothing giant H&M recordedgrowth of 16.5% in its turnover over the last ninemonths (December to August), against only 3.8%over the whole of 2013.

With the positive trend with respect to demand likely to be confirmed, our assessment of the risk remains medium.

5

6 SECTORSPANORAMA

GROUP

(2) See Coface Panorama, "European airlines: forced to change", September 2014(3) Revenue-Passenger-Kilometres, i.e. the revenue per kilometre travelled per passenger

TRANSPORTATION

The sector’s performance is closely linked to worldgrowth and the dynamics of international trade. In2014, world growth accelerated for the first timesince 2010 and this trend should continue in 2015,even though the recovery is weaker than expected.It should coincide with stronger growth in worldtrade, forecast at 5% by Coface (against about 3%over the course of the last two years). In this context,passenger transport is showing strong performanceeven though the traditional European players are still facing difficulties(2). The same goes for air freight,where Europe is also suffering from the effects of theRussian embargo on its trade. Finally, maritime

freight is growing in 2014, after a sluggish 2013. CMACGM posted turnover growth of 3.2% over Q1 (-1.4%in 2013), while the Maersk group recorded growth of1.6% over the same period (-4.3% in 2013).

Western Europe Air passenger transport is very dynamic in theregion. Over the first eight months of 2014, busi-ness grew by 6.1% (in RPK (3), IATA). However, notall the airline companies are benefiting from thispick-up in demand. The low-cost carriers havegrabbed the majority of the increase in demand.

6

Emerging Asia Still supported by demand, the sector is showingstrong growth as evidenced by the opening of 51new sale points in China by the Swedish firm H&M(+25%). E-commerce is also supporting thisgrowth: Inditex has just launched sales lines inSouth Korea and H&M in China.

More up-stream, the cotton market has beenshaken in Asia by the announcement of the Chi-nese authorities that they are reducing the duty-free import quota for cotton. In effect, the worldNo 1 cotton importer wants manufacturers to turnto the major domestic suppliers. As these are oflower quality, foreign supplies have usually beenpreferred. China will therefore reduce the volumeof duty-free cotton to the minimum threshold setby the WTO at 894,000 tonnes, against about1,500,000 tonnes in 2014. Beyond this limit,imports will be taxed at 40%. Already, over thefirst nine months of the year, China has imported38% less cotton than a year ago. In the otheremerging Asian countries, Indian production isexpected to reach record heights this year, sup-ported by favourable weather conditions, enablingIndia to become the No 1 world producer aheadof China. Clothing production in Bangladesh,which has the lowest hourly labour cost in theregion ($.68 per month against $.70 in Vietnamand $.74 in Indonesia) remains very dynamic.Indian and Chinese investment in the region willcontinue to support the sector.

With strong demand and abundant cottonharvests, the sector remains robust. Howeverthe effects on local production costs due tothe reduction in Chinese cotton imports stillneeds to be watched. Our risk assessmenttherefore remains medium.

North America Cotton harvests for the 2014/1015 season willreach record volumes in the United States (theworld's 3rd largest producer), with an expectedvolume growth of 3.8 million tonnes (ICAC). Onthe demand side, thanks to the healthy state ofAmerican employment, the sector has held upwell compared to Europe. H&M has recorded a22% rise in sales over the last ten months (Decem-ber to August). Admittedly, the rate of growth isslowing but it is stabilising at around 2% in annualvolume.

Our assessment of the risk remains medium.

7SECTORSPANORAMA

GROUP

Variations in clothing sales (%, volume, annual average)

Sources : Eurostat, U.S. Census Bureau

10

8

6

4

2

0

-2

-4

-6

Eurozone France

United StatesUnited Kingdom

Germany

2010 2011 2012 2013 2014

Aircraft orders also show this dichotomy betweenthe legacy and low-cost carriers. EasyJet has exer-cised options for 27 additional Airbus 320 planesand Ryanair has ordered 200 Boeing 737Max 200aircraft. In contrast, Air Berlin has cancelled anorder for 15 Boeing 787 and 18 Boeing 737 planes,in order to carry out a restructuring programme. Inthis strongly competitive context, the increase inairline tickets in Europe is continuing to slow, risingby an annual rate of only +0.6% in September 2014(Eurostat).

The situation of the legacy airline companiesneeds particular attention. Our assessment of the risk remains medium.

Emerging Asia The number of households with access to airtravel is growing considerably and supporting thesector, which grew by 6.8% at the end of August(in RPK, IATA). Moreover, regional trade makesthis region the most important in terms of air-freight, with a market share of 21.6% (IATA).Though the pace of GDP growth is stabilising, Asiawill see the strongest growth in trade in 2014 (+5%in exports and +4% in imports according to theWTO). This will also support the growth of mar-itime freight.

Our assessment of the risk remains medium.

North America The air transport sector is benefiting from pastrestructuring. While the market is showing signsof maturity with growth of only 2.7% at the end ofAugust (in RPK, IATA), the profitability of airlinesremains above that observed in Europe. However,investments have been constrained by thisrestructuring. In the United States, the averageage of aircraft fleets is 12.5 years - against 8.9 inEurope, 8.2 in Asia and 6.9 in the Middle East(IATA, 2013). In the long run, fleet renewals will hitairlines' margins. Meanwhile, the strength ofgrowth in the United States will contribute to theresurgence of business class travel and freighttransport.

Prospects remain favourable, thanks to thehealthy state of American growth. As far asthe air transport sector is concerned, carriersneed to improve their financial health todemonstrate their ability to modernise theirfleets. Our assessment of the risk thereforeremains medium.

World trade and exports (%, annual variation)

Source : WTO

Hierarchy sectors in Western Europe

Sectorial risk assessment

AutomotivesMetalsConstructionChemicalsPaper-WoodPharmaceuticalsElectronics, IT

EngineeringEnergyTransportation RetailAgro-foodTextile-clothingServices

HIGH

RISK

MEDIUM

RISK

7

6

5

4

3

2

1

0

2011 2012 2013 2014 2015

World trade(04/2014)World trade (09/2014)

Europe (exports)Asia (exports)

United states (exports)

8 SECTORSPANORAMA

GROUP

Sectorial risk assessmentmethodology

Coface’s assessments are based on the financialdata published by over 6,000 listed companies inthree major geographic regions: Emerging Asia,North America and the European Union 15.

Our statistical credit risk indicator simultaneouslysummarises changes in four financial indicators:turnover, profitability, net indebtedness, and cashflow, completed by the claims recorded through our network.

STUDY

EUROPEAN PHARMACEUTICAL COMPANIES: IS AUSTERITY FATAL?

BY OUR ECONOMISTS

Khalid AIT YAHIAEconomist

X XXXXX Direction de la rechercheéconomique, Coface

gies, as well as their economic model,forcing them to reinvent themselves,to conquer new fields and new geo-graphic areas. The sector has manystrengths, which make us optimisticabout the ability of pharmaceuticalcompanies to seize these redeploy-ment opportunities. Is the sector capable of overcomingthe new challenges facing it? Whereare the sources of growth for the phar-maceutical companies in difficulty ontheir traditional markets?

To address the issues affecting thepharmaceutical world, we must firstunderstand the factors influencingdrug companies. We will do this byanalysing the pressures exerted by thedifferent crises they have faced since2007. We will then highlight the newforces which are imposing a paradigmshift on companies, the new organisa-tional models already implemented bythese players and which offer newgrowth prospects in the short andmedium term.

The 2008-2009 crisis was felt byevery sector of activity. It has durablyaffected the advanced economies, as shown by the exceptional slownessof the recovery. In our view, this is wellillustrated by the pharmaceuticalindustry in Western Europe, as thisindustry was seriously undermined bythe measures adopted by govern-ments in difficulty to cut public spend-ing. However, a revolution of a morequalitative nature impelled the playersin this sector to change their strate-

Since the early 2000s and during the first round ofthe post-Lehman Brothers crisis, health spendingon pharmaceuticals as a share of GDP increased.This expenditure rose from 7.3% of GDP in 2000,to 9.2% in 2009, according to the OECD. Nearlythree quarters of the spending was, and continuesto be, funded by governments - a situation whichquickly became unsustainable in a context of per-sistently weakened growth. One of the peculiaritiesof the European health systems is that the publicsector acts as paymaster for the services providedto the population, thereby giving it real power tocontrol (or even fix) the price of medicines, as wellas profit margins.

Confronted with the sovereign debt crisis, the pres-sure on governments to reduce their deficitsincreased dramatically. To maintain the supply of

care in the face of ever-increasing public demand,the public authorities put control measures in place(“ring-fencing”). We note, however, that the shareof spending on medicines in total healthcarespending has been falling constantly for more than10 years, down from 14.9% (in 2003) to 13.4% (in2011).

A fact: lower spending on medicines since the crisisThe pharmaceutical industry is regulated bypublic authorities because of the considerablehealth and social issues. Accordingly, the deci-sions taken by the authorities strongly influencethe activities of pharmaceutical companies.Whether these decisions are marketing authori-sations, or the determination of the amount of

HAS THE PHARMACEUTICAL SECTOR SUFFERED FROM THE ECONOMIC CRISES?

1

« Pharmaceutical companies aredealing with multiple challenges :constraint in health spending, competition from generic drugs,increasing State’s regulation… »

9SECTORSPANORAMA

GROUP

reimbursement, dedicated public agencies exer-cise sovereign power over these aspects. Thesuccessive crises since 2007 have forced Euro-pean governments to curb the rise in healthspending.

Thus, as can be seen in Chart 1 below, sales ofprescription medicines in the 5 major westernEuropean countries have been falling steadilysince 2010.

This is a “soft” measure, where rather than requir-ing pharmaceutical companies to lower theirprices, governments argue that that they do notwant to pay more for products that costs less inneighbouring countries. Generally, the prices serv-ing for comparison are those used by the Britishauthorities, as they are considered among thecheapest in Europe. Thus countries such as France,Italy and Japan and Canada take the prices in theUnited Kingdom as a benchmark, thereby max-imising the impact of the decisions taken in thatcountry (which accounts for nearly a quarter ofthe world market for sales of pharmaceuticalproducts).

Another common practice is to benefit from dis-counts on the part of the pharmaceutical compa-nies, if the estimated budget for a drug isexceeded. Thus, if the total post-estimate costexceeds the budget, the producer undertakes topay all or part of the excess into the repaymentsystem.

Finally, since well before the advent of the worldcrisis, most European countries have been tryingto encourage the use of generics for medicineswhich have come into the public domain. Genericmanufacturers obtain a permit to put their copy onthe market several months before the patent forthe original lapses and it really comes into the pub-lic domain. Doctors are rewarded for all prescrip-tions of generics, as are pharmacists who proposea generic substitute. In addition, the health insur-ance branch of the Social Security system in Francegives higher refunds when the patient agrees totake a generic medicine. Chart 2 illustrates theincreased use of generics to the detriment of pro-tected medicines. Even though generics still onlyrepresent a quarter of the value of the drugs mar-ket, this share has been growing continuously for5 years. Volume has increased more strongly andin 2013 the relationship was 46%-54% in favour ofgenerics.

The crisis has therefore accelerated the reductionin health spending, in particular the amountdevoted to medicines.

Chart 1:

Change in prescription medicine sales by value in the European big 5

(France, Germany, United Kingdom, Italy and Spain)

Chart 2:

Evolution in value of sales of generic drugs in Europe

Source : Evaluate Pharma

Sources : IMS Health, MIDAS.

3%

2%

1%

0%

-1%

-2%

-3%

-4%

100%

75%

50%

25%

0%

2.1%

-2.8% -2.7%

-1.3%

2009/2010 2010/2011 2011/2012 2012/2013

2009 2010 2011 2012 2013

These negative changes are paradoxical in view ofthe underlying trends affecting western societies -and in particular those of Western Europe. Facedwith an aging population with a high demand forhealthcare (and affected by chronic illnesses thatcan prove disabling), healthcare spending wouldhave been expected to increase sharply, or at leastto grow positively in recent years. It is the speedwith which the authorities have limited spending onmedicines that has been surprising. Several reasons can be suggested to explain this fall.We present those which seem to us to be the mostconvincing.

Falling prices and policies favouringgeneric medicinesWell before the development of the 2007 crisis,European countries tried to keep the growth ofpharmaceutical spending under control. Accordingto the OECD, spending on medicines at currentprices grew by 30% between 2003 and 2007. Sev-eral measures have been introduced to curb thisrise, depending on the nature of each country'shealth system.

One of the best-known measures was to demanda cut in the prices not only for medicines still pro-tected by patents, but also for generic medicines(as in France, Spain and Portugal). According toDeloitte, these cuts may lead to a chain reaction inother countries, which set their prices in accor-dance with those of the reference countries.

GenericsNon generics

10 SECTORSPANORAMA

GROUP

Chart 3:

Sales of medicines whose patents are expiring,

in billions of dollars

Financial measures have been introduced, firstly tocombat cost inflation resulting from medicine con-sumption, and secondly to curb the surge in con-sumption in the face of macro-economic shocks. Inaddition to the pressure due to the problems ofpublic debt, problems specific to the sector are alsoaffecting its situation.

The patent cliff

The patenting process for medicines works as fol-lows. A pharmaceutical company, after havingobtained a marketing authorisation from a Medi-cines Agency, has several years to recoup and profitfrom the sums it has invested in developing andmarketing a new medicine. Several figures are cir-culating on the costs of a new molecule and onaverage this is currently nearly $1.5 billion (against1 billion at the beginning of the 2000s).

Given the colossal sums spent, a new medicine mustbe protected by a patent in order to guarantee thepharmaceutical company the right to benefit fromthe fruits of its research. In pharmaceutical jargon, amedicine that generates more than a $1 billion ayear is called a “blockbuster”. The patent lasts for20 years and therefore allows costs to be recov-ered, if marketing conditions do not harden in themeantime.

Pharmaceutical companies made great strides interms of research during the 1980s. This period wasfollowed by the marketing of medicines that havesince become blockbusters. In the years since 2010,the pace of the loss of patents has accelerated, lead-ing to a fall in revenues for these companies (Chart3). Effectively, once a medicine loses its patent, it isquickly copied by a generic producer and the copyis authorised to enter the market before the targetdate for loss of the protection. The subsequent rev-enue decline is estimated to be between 75% and90% of the previous year's sales - a decline whichhas accelerated since public authorities have beenstrongly encouraging the use of generic substitutes.

According to HIS, in Europe patents on Herceptinand Rituxan (Roche), Lantus (Sanofi), and Remi-cade (Merck & Co) will be expiring. This periodwill last until 2020, with a consequent loss inearnings between 2014 and 2016 estimated atover $120 billion.

The value-based pricing

The regulated nature of the medication sectoralso affects the performance of the big Europeanpharmaceutical companies. The influence of gov-ernment agencies makes itself felt throughout allthe key stages in the product’s life. A medicinemust obtain a marketing authorisation (from amedicines agency) before it can be made availablein pharmacies). It must also be able to prove that itis not harmful to patients and that it has real thera-peutic value. In our public healthcare systems, a pay-ing agency takes responsibility for all or part of theprice of the medicine, in order to guarantee indis-criminate universal access to health care. This payingbody will decide to reimburse only after having car-ried out a rigorous cost-benefit analysis of the treat-ment. The pharmaceutical company must thereforeprove that the new treatment brings value to thepatient (Value Based Medicine, VBM) in terms ofquality of life and/or additional length of life, relativeto the cost (the price) borne by society.

This is particularly the case for treatments for com-plex, and hitherto difficult to treat, pathologies, lead-ing to a loss of control by pharmaceutical companiesover their treatments, in favour of governments andpublic paying agencies.

It is interesting to note that these practices areincreasingly important in European countries – andespecially in the United Kingdom and Germany. Forexample, in the United Kingdom, NICE (NationalInstitute for Health and Care Excellence), whichdepends on the NHS, compares the results of clinicaltrials in order to determine the clinical effectivenessof a treatment. Thus the determined value is setagainst the cost (the price asked by the pharmaceu-tical company), giving NICE the responsibility ofapproving or rejecting the possibility of refunding.This body is regularly decried for its rejections con-cerning the refunding of anti-cancer treatments.

Source : Evaluate Pharma

60

50

40

30

20

10

0

NEW SHOCKS TO ABSORB220

06

2008

2010

2012

2014

2016

2018

2020

19 20

16

2630

34

53

33

43 4440

30

3539

26

11SECTORSPANORAMA

GROUP

Generally the pharmaceutical company agrees toreduce its price in order to get NICE to guarantee itsagreement on repayments. It is, however, necessaryto take two elements into account. Firstly, faced withthe problems posed by public opinion regardingthese rejections, the Cameron-Clegg governmenthas created a fund of £200 million to fund anti-can-cer treatments, which is supposed to last until 2016.Secondly, since January 2014, the British publicauthorities have gone even further in the implemen-tation of VBM by paying only for treatments thatbring a real therapeutic improvement (“break-through drugs”) over existing treatments, rather thantreatments that bring only a marginal improvement.This is in order to get around the development of'me-too' medicines, which largely duplicate the ther-apeutic action of those already on the market, with-out bringing real improvements. So, if a newmedicine brings only an incremental and not decisiveresult, the outcome of the consultation to decidewhether the NHS can pay for it will be negative. Inother words, to be able to benefit from a positiveresponse from NICE, the medicine needs to givepatients additional years of life at a cost acceptableto society.

The other European country which is acting as a pio-neer in terms of implementing VBM is Germany. Atthe end of 2010, the Act on the Modernisation of theMedicinal Products Market was passed, to limit thecost of pharmaceutical products. As a result of thisAct, for every new molecule or new combination ofexisting molecules, a cost-benefit approach has tobe conducted by an evaluation agency (IQWiG) inorder to specify its value for the patient. As value isa difficult concept to measure, it is the clinical benefitthat is assessed. So, if a molecule is analysed as bet-ter in terms of clinical benefits than a reference treat-ment, it will be refunded at a higher price. However,if there is no possible basis for comparison, the com-pany must accept a lower, non-negotiable price,which can be awkward for treatments which bring areal improvement in therapeutic areas where rare ill-nesses predominate. Some pharmaceutical compa-nies have refused to market their new medicines inGermany because of these rules, which they con-sider unfair and for which the decision-makingprocess is thought to be too complex and unpre-dictable. Boehringer-Ingelheim and Eli Lilly have,therefore, decided not to launch their Trajenta (atype 2 diabetes medicine) in Germany. However,AstraZeneca has been able to benefit from a pricenegotiated for its Brilique anticoagulant, as, accord-ing to the German assessment agency (IQWiG), it offered a real therapeutic improvement when com-pared with Sanofi’s Plavix.

A European agency judged too slowly?Since November 2005, all new medicines must beapproved by the European Medicines Agency(EMA) in order to be able to access European mar-kets. For this reason a pharmaceutical companythat wants to market its medicine must prove itsclinical effectiveness, as well as the absence of anydanger for patients. This is shown using the datacollected from various clinical trials. Generally, thesame data is used when the case is submitted forapproval in the United States and in Europe. How-ever, despite the relative similarity of the casespresented, the FDA (Federal Drug Agency) andthe EMA have different approval times.

According to a study by Ramshi Shah published inSeptember 2013 in the British Journal of ClinicalPharmacology, the EMA took an average of 410days to deliver its approval for a class of anti-cancer drugs, while the FDA(…) took only 205days. The causes of this difference are attributableto “clock stops", or the demands of the authoritiesfor clarifications from the pharmaceutical compa-nies. The other factor is linked to the length of thefinal approval process by the European Commis-sion after the CHMP (the body of scientists whicheffectively gives its agreement within the EMA)has approved the active agent. This time lag hasbeen estimated, for this class of anti-cancer med-icine, as 90 days on average.

Other factors can come into play and explain theselonger delays on the European side. These includethe fact that the EMA is a collegiate body in whichthe authorities of each country must give theiragreement, whereas the FDA is a single federalauthority. In addition, since 2012, there has been arapid submission procedure in the United States,called the “Breakthrough Therapy Submission”.This makes it possible to grant faster marketaccess for life-threatening illnesses. A year after itsintroduction, 30 out of 80 applications have beengranted. A somewhat similar initiative taken by theEMA was launched in a pilot form in March 2014.

« State backed agencies play an essential rolethroughout the stagesof a product life »

12 SECTORSPANORAMA

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Pharmaceutical companies therefore face the dualchallenges of cuts in health spending and growinggovernment regulation of their industry. To meetthese challenges, they have had to set out to con-quer new markets and new therapeutic domains,both niche and more remunerative, even if theresearch there is more complex and therefore morecostly. Nevertheless, European pharmaceutical com-panies benefit from a good base in the developingcountries, which are genuine reservoirs of growthfor these groups.

Roche and Novartis illustrate the importance of thisredeployment towards more remunerative domainsfor pharmaceutical companies.

WHY IS AUSTERITY NOT FATAL?3lacking in their own traditional markets. Becausethe main European pharmaceutical firms have agood base in the emerging countries, they can use this to counterbalance their ailing Europeanmarkets. Thus, as one can see in Chart 4, the bigpharmaceutical companies’ shares in sales of phar-maceutical products range from 14% to 36%.

Graph 5 illustrates the sales growth rates of thesegroups in the emerging countries. Except in thecase of GSK and Merck KGaA, the industry showsreal dynamism.

Table 1 illustrates the fact that growth in spend-ing on medicines in 2017 will come from thedynamism of some emerging countries, prima-rily China, India and Brazil.

Developed markets Pharmerging

Germany 1 - 4% China 15 - 18%

France (-1) - 2% Brazil 11 - 14%

Italy 0 - 3% Russia 9 - 12%

Spain (-4) – (-1)% India 11 - 14%

United Kingdom 1 - 4%

Advanced 1 - 4% Pharmerging 11 - 14%

Several factors may explain this dynamism.

Firstly, the population of emerging countries isaging rapidly. Chart 6 page 14 below shows thatthe proportion of over 50 year-olds has beengrowing over the last 16 years. A few years ago,these countries were still known as having youngpopulations. A demographic revolution is takingplace. China, for example, because of its one childpolicy, is losing its demographic dividend and isseeing its proportion of over 50s reaching 28% ofthe total population. An aged population con-sumes more pharmaceutical products comparedwith younger age brackets. However, these seniorsmust be given access to healthcare. This fundinggap due to aging and the prevalence of new ill-nesses is being tackled head-on by governments,in order to guarantee medical cover to older peo-ple, whether employed or not. Thus, in the early2010s, China extended the public health insurancesystem to the elderly, after having previouslyfavoured private cover in the 1980s. In 2003 Brazilpassed an Older Persons Law, which aims toimprove the quality of life of the oldest, with ahealth programme which facilitates access to careand particularly to pharmaceutical products inpublic health institutions.

Table 1Annual growth rate forecasts for medicine sales in the“Pharmerging” countries and in developed countries.

Sources : IMS

The emerging countries(“pharmerging” markets), drivers of growth?As with the automobile sector, players in the phar-maceutical industry are turning towards the devel-oping countries in order to achieve the growth

Chart 4:

Major European groups’ shares of sales in emerging countries and Europe in 2013.

Chart 5:

Sales growth rates of the major European groups in emerging countries

0% 5% 10% 15% 20% 25% 30% 35% 40%

Merck KGaA

Sanofi

GSK

Novartis

AstraZeneca

Roche

Source : The companies’ published accounts

Source : Companies’ published accounts

Merck

KGaA

Sanofi

GSK

Novartis

AstraZeneca

Roche

14%

12%

10%

8%

6%

4%

2%

0%

37%36%

25%

13%

8%

6%

1%

4,4%

2%

14%

25%21%

36%24%

28%25%

24%33%

13SECTORSPANORAMA

GROUP

EuropeEmerging countries

15

2219

28

14

18

29

36

14

18

33

38

Another factor is the prevalence of new patholo-gies linked to life style. The economic develop-ment of the emerging countries tends to set themon the trajectories already followed by the devel-oped countries. Thus, from a health perspective,the rapid development of illnesses linked to obe-sity is a characteristic shared by countries such asChina, Mexico and Saudi Arabia - where cases ofdiabetes and cardio-vascular diseases are on therise. These pathologies require high consumptionof medicines. In fighting chronic illnesses, particu-larly cardiovascular diseases and diabetes, thethree most prescribed medicines in the emergingcountries are Plavix, Liptor and Lantus. Accordingto the IMS, they total over $1.6 billion in the emerg-ing countries. Sales of medicines in emergingcountries are expected to reach $400 billion in2017 (against about $220 billion in 2012), and torepresent nearly a quarter of world sales. Never-theless, although the pharmerging countries seemto constitute an Eldorado for the world's phar-maceutical firms, they are closely following thechanges currently occurring in Europe and, in particular, the cost control measures. The authori-ties are accordingly demanding price cuts andmaking the conditions of access more difficult.Nevertheless, the price cuts are offset by theeffect of bigger volumes.

The therapeutic areas of the futureThe loss of patents on flagship medicines,together with the competition from generics,has impelled the pharmaceutical firms to targetmore remunerative complex pathologies.

These pathologies belong to therapeutic areaswhich are currently reporting a sharp increase insales. We have seen that lifestyle influences theillnesses developed in the course of a person’slife. Cancer and its many forms are proving to bea value-generating field for pharmaceuticalcompanies in the developed world. As we areliving longer and our food is richer, cases of cancer are increasing. Oncology is becoming animportant therapeutic area. These are two newsources of sales.

Chart 7 is revealing in this regard. In 2017 oncol-ogy will occupy by far the leading position intherapeutic areas in 2017. The pharmaceuticalfirms are rushing towards increasingly complexand costly treatments, in order to unlock theirvalue. This enthusiasm translates into a signifi-cant increase in the number of molecules in thepipeline (in the clinical trials phase). This trendis illustrated in Chart 8 below.

Chart 6:

Comparison of the proportion of over-50s in the population

of some emerging countries

Source : EIU

Chart 8:

Number of medicines in the three most important therapeutic areas approved

by the FDA between 2004 and 2013

Chart 7:

Sales in billions of US dollars, in 2017, for the three most important

therapeutic areas

Source : IMS Health

0 20 40 60 80 100 120

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Oncology

Pain

Diabete

40

35

30

25

20

15

10

5

0

Brazil China India Russia South

Africa

United

Kingdom

20012016

8

3

6

5

2

3

4

5

8

9

Source : IMS Health

14 SECTORSPANORAMA

GROUP

The European pharmaceutical firms are still suffer-ing from the repercussions of a period of austerityin their domestic markets leading to a slowdown,or even a halt, in the growth of public spending onpharmaceutical products. Competition from gener-ics, particularly when a patent expires, has addedto the difficulties of a sector in a delicate situation.The application of cost-benefit comparison proce-dures by the reimbursement agencies, seeking toassess the value of treatment for each patient, is afurther obstacle which is difficult to overcome.Uncertainty over the level of reimbursement for amedicine has led to a redefinition of the sector’seconomy.

CONCLUSION4As a result, European pharmaceutical companiesneed to redeploy and find new sources of profit. Forthis they have a good base in the emerging coun-tries, where sales growth offsets the difficultiesencountered in Europe. Moreover, in order to max-imise their chance of success when medicines areapproved, they are collaborating with public or pri-vate research institutions so as to target the mostpromising therapies. The fight against the illnessesof the 21st century is contributing to the develop-ment of high value-added medicines, enablingpharmaceutical companies to limit the impacts of the fiscal austerity that seems to be becomingpermanent in Europe.

Partnerships are becoming necessaryOur societies find it hard to accept the develop-ment of these illnesses and they therefore agreeto great financial efforts to cure them. The publicauthorities are involved through various researchtrusts and funds, managed under the aegis of pub-lic medical research agencies. Moreover, and thisis a point worth emphasising, the pharmaceuticalfirms are increasingly collaborating with publicmedical research bodies and university centres inorder to target the causes of certain illnesseswhich are difficult to treat. Sanofi is collaboratingwith the Massachusetts General Hospital, one ofHarvard University’s hospitals, in fighting cancer-ous tumours, in particular those related to theblood. The same goes for AstraZeneca, which iscollaborating with Cambridge University’s MedicalResearch Centre in the United Kingdom, on thedetection of genes causing illnesses.

This genetic detection is a way of getting therefunding bodies to accept expensive treatmentsbecause by accompanying the treatments with acompanion test, the companies are trying extractthe maximum value from their products. In effect,this enables a population of patients to be tar-geted, thus reducing suffering for particular ill-nesses, and consequently relieving pressure on thebudgets of the different health insurance organi-sations. An example is breast cancer, which can bemore serious where the gene HER2 is present.Roche, through its subsidiary, Ventana, has devel-oped a test which indicates the presence of thegene. Those patients who test positive are treatedwith Kadcyla and Perjeta (both produced byRoche).

15SECTORSPANORAMA

GROUP

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