Strategic responses to institutional changes: ‘Indigenous growth’ model of the Indian pharmaceutical industry

Abstract

This paper examines the strategic response of the Indian pharmaceutical industry to the dual institutional changes arising from economic liberalization of the Indian economy and the WTO mandated intellectual property regime. An analysis of the relative position and growth of Indian firms vis-à-vis foreign multinationals, changes in the resources and capabilities of these firms, and scope in terms of product market internationalization and overseas acquisitions during the 1995–2005 period, suggests an ‘indigenous growth’ model in the Indian pharmaceutical industry which is in contrast to the FDI initiated growth witnessed through full or partial privatization of state-owned firms in other geographical contexts. Second, internationalization of both inputs and product markets has been the dominant mode to overcome the pressures arising from institutional changes. We discuss the drivers of this model and provide implications for future research on strategic responses to institutional changes within other industries in India as well as for comparative research across different political and institutional settings.

Introduction

During the past two and a half decades, a number of developing countries around the world have undertaken economic reforms of varying magnitude (Hoskisson et al., 2000, Wright et al., 2005) with the objectives that include: (i) a move away from inward-oriented import substitution policies towards outward-oriented export-led growth (Kotler et al., 1997), (ii) access foreign technology and capital in order to make domestic firms competitive in the global economy, and (iii) enhance capabilities in value-added industries rather than relying on traditional commodity goods (Aulakh et al., 2000, Thomas et al., 2000). While much of the earlier studies on economic liberalization focused on understanding the motivations behind macro-policy changes in individual countries as well as the specific market and investment opportunities afforded by liberalizing economies to foreign multinationals (e.g., Gillespie and Alden, 1989), there is a growing interest in understanding the competitive strategies of firms from these economies as they respond to institutional transitions and begin to compete in global markets (OECD, 2006, Business Week, 2006, BCG, 2006). Part of this interest arises from unique business models of these firms derived from the diverse institutional contexts as some of them transform to ‘emerging multinationals’ directly competing with the ‘traditional MNCs’ from developed economies.

The purpose of this paper is to provide some insights into the organizational transformations in the context of post-liberalization India. In particular, we examine the Indian pharmaceutical industry and trace its development over a decade to get an in-depth understanding of the impact of institutional changes on organizational transformations. The Indian pharmaceutical industry presents a compelling case of industry-wide transformation in response to severe reform measures. As described in detail later, the Indian pharmaceutical industry faced a dual impact of economic liberalization and changes in intellectual property regime in the mid-1990s, threatening its very sources of competitive advantage. However, despite these external challenges, the industry as a whole has witnessed a transformation in the last decade and along with the IT and automotive equipment sectors, is now considered one of the main drivers of India's export-driven growth. Finally, the resurgence and growth of the industry is completely ‘organic’, driven by indigenous Indian firms (none of which are state-owned) and this rise is achieved in an R&D intensive oligopolistic industry with major entrenched MNCs from developed economies. A study of organizational transformation in this industry has the potential to provide important insights to the nascent literature on emerging economy firms.

In a recent report titled “The New Global Challengers”, Boston Consulting Group (BCG, 2006) identifies 100 emerging multinationals from developing economies and provides some descriptive data of these firms as well as speculates on the underlying reasons for their growing success. China (44) and India (21) together represent almost two-thirds of these emerging multinationals. The report further makes an interesting comparison between Chinese and Indian companies on the list (p. 9):

Where the globalizing Chinese companies differ dramatically from the globalizing Indian companies is in their ownership structures. More than two-thirds of the Chinese companies… are state owned and state controlled, often with publicly traded subsidiaries or with minority stakes in the hands of strategic investors…. Of the remaining companies, some have a mixed-ownership structure but only four Chinese companies on the list are privately owned. The shares of the Indian companies are usually divided among private owners, strategic investors, and the general public, with no single investor possessing a majority stake. All the Indian companies on our list are publicly traded… and only one Indian company on the list is state controlled.

Along with this comparison, the BCG Report notes that none of the 100 firms in its sample comes from Eastern Europe, “because the large globalizing companies in these countries are actually subsidiaries of foreign multinationals” (BCG, 2006, p. 8). These observations thus suggest that there are unique models of responding to institutional changes arising from economic liberalization across the three geographical contexts although major liberalization efforts were initiated in the same time-period.

Institutional changes resulting from economic liberalization can be broadly grouped into three major categories (Ray, 2003): a) privatization or change of ownership of key sectors of economy from government to private sector; b) founding and development of market institutions to bring about efficient intermediation in financial, legal, labor and regulatory domains (Khanna and Palepu, 1997); and c) improvement in the efficiency levels of market players as well as institutions propelling a movement towards more perfect markets. While the institutional changes experienced in the centrally planned command economies such as China and Eastern European countries encompassed changes in all the three categories, mixed economies such as India are characterized by changes predominantly in the third category. There was always a dominant presence of privately held, both indigenous and foreign, firms in India. Hence, in the erstwhile socialist economies, an important component of economic liberalization was through full privatization of state-owned enterprises (e.g., Eastern Europe) or partial privatization (e.g., China through the mode of equity joint ventures). This, in turn, brought about dramatic increases in inflows of foreign direct investment (FDI) and led to high rates of growth, primarily driven by inward FDI.

While India too is witnessing high rates of economic growth almost matching China's, such growth was achieved, conspicuously, without the aid of any steep increase in FDI inflows (Huang and Khanna, 2003). India also was markedly different due to the presence of a reasonably active capital market, functioning legal and regulatory institutions, and a number of well-established business schools and educational institutions generating managerial talent for decades (Thirlwell, 2006). In addition, due to democratic traditions, the pace of the reform process in India was slower compared to the transition economies and came to be distinctly known as a ‘gradualist’ approach of liberalization (Ahluwalia, 2002). These differences in the nature and pace of institutional changes in India resulted in organizational transformations that are distinctly different from the predominantly defensive choices of emerging economy firms proposed by the limited extant theory (Ghemawat et al., 1998, Craig and Douglas, 1997, Dawar and Frost, 1999, Khanna and Palepu, 2006) and empirical studies in other liberalizing economies (Child and Lu, 1996, Peng, 1997, Suhomlinova, 1999). One of the striking findings of our study is the emergence of active internationalization as a key strategic choice of the Indian pharmaceutical industry, as individual firms responded to severe institutional changes. Internationalization has been not only in the product market front but also in inputs (resources) and has been used as a strategic tool to build the capabilities required to successfully adapt to the new institutional imperative.

The rest of the paper is organized as follows: a brief review of the extant research on organizational response to economic liberalization is provided in the next section, followed by an outline of the historical evolution and institutional changes undergone by the pharmaceutical industry in India. We then examine the organizational transformation in the Indian incumbent firms by tracking the trends in three critical dimensions — relative position and growth of incumbent firms vis-à-vis foreign multinationals; changes in the resources and capabilities of incumbent firms; and change in the scope of incumbent firms primarily in terms of product market internationalization and overseas acquisitions. Lastly, some of the unique features of organizational transformation characterizing Indian firms are highlighted along with several distinguishing characteristics of the Indian institutional context that could possibly be the reason behind this. We conclude by highlighting the need for more fine-grained research in the Indian context given its distinctive institutional features to confirm and build on our findings from this exploratory research.