Industry Must Adapt To Emerging Trends That Threaten Recent Economic Gain

The OTC industry must adapt to evolving market trends as the global economy recovers in order to maintain the market share it gained during the recession, said experts at a European industry conference.

The OTC world escaped relatively unscathed from the current recession, and even may have benefited from it, said Sarv Khunkhuna, head of business development for healthcare and pharmacy for Boots, a U.K.-based pharmacy and retail outlet.

During Nicholas Hall's Insight 21 European OTC Conference and Action Workshop April 14-16 in Istanbul, Turkey, Khunkhuna explained consumers continued to buy OTCs even as they deferred spending on big ticket items, such as cars, when the economy began faltering in the U.S. in 2004 after interest rates rose following a period of unsustainable growth.

He added many consumers continued to spend a larger portion of their income on OTCs after the economy plummeted sharply following the U.S. Federal Reserve's warning in 2007 of a $100 billion shortfall in loan repayments and the failure of several key financial institutions in 2008.

Indeed, "life was just fine in the OTC world" in 2009, even as other industries continued to struggle, agreed Natalie Blyth, managing director and global head of consumer and OTC healthcare at HSBC Investment Banking in the U.K.

As evidence, conference chairman Nicholas Hall noted, 2009 global OTC sales grew 4.6 percent to €66.3 billion ($95.24 billion at Jan. 1, 2010 conversion rates) - defying expectations they would flat-line or dip below 2008 sales of €63.4 billion ($91.07 billion) (¹ (Also see "Tracking Consumer Evolution Is Key To Recession Resistance" - Pink Sheet, 11 May, 2009.)). He added that 2008 OTC sales grew 4.3 percent over 2007 sales of €60.8 billion ($87.34 billion). Comparatively, the OTC market grew 5.2 percent in 2007.

Global OTC Exceeds GDP

Hall noted global OTC sales in 2009 for the first time considerably outpaced the global GDP, which fell 0.8 percent.

Typically, the global OTC market "aligns very closely with the global growth rate - usually sitting on top of it by 1 percent difference," he said. In 2008, the OTC market grew 1.3 percentage points above the global GDP and in 2007 the OTC market and global GDP growth rates were the same.

The difference between the OTC growth rate and the global GDP in 2009 shows "in times of a troubled economy, consumers will put their hands in their pockets and give us a greater share of their expenditure than in normal times," said Hall.

During a recession consumers often buy more OTC drugs because they cannot afford to visit a physician or take a day off work.

Hall and other experts said whether consumers' preference for OTC products will continue as the economy improves or whether sales will dip back down to 1 percent on top of the global growth rate will depend on how the industry and individual firms adapt to changes in the marketplace.

Blyth pointed to signs the economy is improving, including rising consumer confidence - up to 92 in March from a low of 77 last April, according to the Global Nielsen Consumer Confidence Index. Other indications are a slight increase in the housing market, improved lending conditions and increases in commodities.

However, Blyth still expects the Western world will "face years of austerity" with "significant natural market volatility" in the short term.

She also agreed with Hall that consumer spending on OTCs could fall as the economy improves. If that happens, "it is not necessarily the strongest that will survive, or the most intelligent. It is the one that is most able to adapt," Blyth observed.

Consumer Confusion Threatens Future Sales

Among the emerging market trends that threaten OTC growth is consumers increasingly are confused by the volume of OTC stock-keeping units, categories, packaging and promotions. In response, they might turn their back on OTCs in favor of less complicated physician guidance.

"The consumer is more and more confused. They go in stores and there are too many brands and SKUs and they don't understand the brands, ads" and endless ingredient combinations, said Hall.

He noted that "if we could make our consumer better informed we could grow the market by 40 percent or close to that."

Some drug stores are aiding confused consumers by reducing SKUs, Hall said.

For example, "Walgreens announced it would cut back from 65,000 SKUs in the health and beauty sector to 45,000. That means 20,000 SKUs will vanish and take a lot of mid-sized companies with them," Hall said (² (Also see "Retailers’ SKU Cuts Heat Up Manufacturers’ Fight For Shelf Space" - Pink Sheet, 18 May, 2009.)).

As a result, he added, some firms are putting themselves up for sale because companies selling $50 million to $350 million annually cannot expect to survive in a retail environment where one-third of SKUs are coming off the shelf. Retailers also are changing their inventory mix to emphasize value, which often means promoting more private label at lower prices, said Khunkhuna.

As the industry already saw, when retailers push private label, brand sales suffer (³ (Also see "Retailers’ Private Label Push Eats Into Name Brand Profits" - Pink Sheet, 9 Mar, 2009.)).

One response to SKU rationalization is to "extend and strengthen" product portfolios by entering high-growth categories where retailers are expanding and bolstering brands in well-established categories to ensure they are not among those cut, said Blyth.

Promotion Fatigue Limits One Strategy

The tried and true strategy of increasing promotions to combat private label competition might not work as well in the evolving market, Khunkhuna warned.

He noted consumers are suffering "promotional fatigue" after retailers aggressively used "killer offers" during the last 18 months to drive sales.

"Killer offers basically are relatively high-ticket items that are slashed to half-price to drive footfall on a temporary basis into shops," Khunkhuna explained. He added that because "everyone is doing the same sort of" advertising, the promotions have "all become wallpaper" and consumers are not responding as well anymore.

Retailers are compensating by differentiating value through their loyalty programs. But loyalty programs do not benefit individual brands as much as more traditional sales, he said.

For example, Rite Aid April 19 announced its "wellness+" customer rewards program in the U.S. It allows consumers to accrue points that they can trade in for free health screenings and additional merchandise discounts.

In part a result of the shift to loyalty schemes, Khunkhuna predicts "retail sales will be flattish, and will feel the pinch in the second half of the year."

"Weaker businesses will continue to struggle and some of them will continue to close down, whereas bigger businesses will emerge bigger and more efficient," he added.

New Competitors See "Oasis" In OTC

As the economy recovers, firms can expect increased competition from outside players that suffered more during the recession, said Blyth.

"OTC is an oasis" in the recession with a resilience attractive to big pharma, which is facing patent cliffs and looking to diversify, she explained (⁴ 'The Tan Sheet' March 23, 2009 and ⁵ (Also see "Schering-Plough Merger Offers Merck OTC Business, Zegerid Switch Rights" - Pink Sheet, 16 Mar, 2009.)). As large companies buy small and mid-sized OTC firms, competition for the remaining OTC companies will be stiffer.

Partnerships and joint ventures with other OTC firms is one strategy to defend against increased competition, she said.

"Use acquisitions to buy your dominating place in your niche," Blyth advised firms. For this to be a viable option though, firms must have financial flexibility, which is not as easy as it was prior to recession, she added.

Re-regulation Increasingly Limits Sales Options

Finally, re-regulation of the industry threatens future sales, Hall said.

"This is an industry that has preached deregulation for years, but now we are seeing things like the U.S. government saying certain ingredients are not safe and should go behind the counter," he noted.

For example, FDA recommended against the use of several popular cough and cold drugs for young children, and moved pseudoephedrine behind the counter in 2006, which caused the ingredient to almost disappear from OTC products, Hall said (⁶ (Also see "FDA Review Of Children’s Cough/Cold OTCs Has Broader Implications" - Pink Sheet, 5 Mar, 2007.) and ⁷ (Also see "Industry Goes On Offensive Against Prescription Pseudoephedrine Trend" - Pink Sheet, 26 Oct, 2009.)).

Also, Australia will make pseudoephedrine a hospital-only prescribed product, and at least two states in the U.S. switched PSE products to Rx-only (⁸ (Also see "Senate Meth Fight Pits Rx-Only Pseudoephedrine Against E-Tracking Option" - Pink Sheet, 19 Apr, 2010.)).

Some firms adapted to PSE going behind the counter by reformulating OTC products with phenylephrine, but sales of those have trailed PSE-containing drugs.

Positive Trends Could Boost OTC Sales

OTC's short-term future may be grim, but it is not hopeless, the experts note.

"We have some fantastic demographic trends that are working for us," Khunkhuna said. For example, "the population is getting older. A person born today will live 16 years longer than a person born in the previous generation. As [populations] get older, they consume more health care."

He added, "Some fantastic disease trends" also work in the industry's favor, such as obesity, "which gives rise to a lot of diseases."

In addition to obesity, which affects one in four people in the U.K., diabetes affects one in three people there, and offers growth potential "if we can tap it," Khunkhuna said.

More active lifestyles also benefit the industry, he said. "We need active lifestyles, but we do not eat as well as we should so there are some fantastic opportunities for nutrition and diets."

Likewise, stress relief products and sleep aids are growing categories, with one in seven people receiving stress treatment and one in three people struggling to sleep well, he added.

Firms also can seek solace from retail pressure by working more with independent pharmacies, which proved to be more resilient than originally anticipated by the industry.

"The independent pharmacy is very helpful. They are coming together in cooperatives to use the techniques of chain marketers, but they are kinder to us in terms of profit margins," Hall explained.

"Unlike the mass retailers that want the mass percentage of profit, the independent pharmacy says there should be profit for both sides and they are interested in growing the market, rather than fighting over the existing market."

Finally, he added, more countries are encouraging consumers who receive government support for drug costs to consider OTC options before seeking more expensive prescription products. Firms can capitalize on this by positioning their products as alternatives to prescription products and as preventive measures.

- Elizabeth Crawford ( ⁹ [email protected] )