(Reuters) - Aggressive consolidation among U.S. and European generic drugmakers is putting pressure on smaller competitors in the industry, whose best hope of surviving a brewing price war may lie in finding specialized niches.
Expiring patents on some of Big Pharma's top-selling drugs is about to flood the market with cheaper copies, driving dealmaking among larger generics makers like Teva Pharmaceutical Industries Ltd, Novartis's Sandoz, Mylan Inc and Watson Pharmaceuticals Inc to gain economies of scale.
At the same time, new regulations in the United States and Europe could cap prices for generic products.
"We are talking here of generics being sold at even below 1 euro ($1.22) a pack in the European Union, and that is simply not sustainable," said Warwick Smith, the director general of the British Generic Manufacturers Association.
So as larger companies bulk up, smaller ones are left with just a couple of options -- specialize or get leaner to stay competitive.
U.S. companies such as Impax Laboratories Inc and Hi-Tech Pharmacal Co Inc and Europe's Stada, Hikma Pharmaceuticals Plc, Krka and Pharmstandard are expected to feel the pressure of the changing market dynamics, industry analysts said.
Recent deals among large generics producers include Watson's $5.6 billion acquisition of Swiss drugmaker Actavis Group and Novartis's purchase of generic dermatology products maker Fougera Pharmaceuticals for $1.5 billion.
"Teva's acquisition of Ratiopharm and the Watson and Mylan deals that moved them from U.S.-focused operations into more European and global presence -- those are the three that really changed the scenarios," said Alan Sheppard, head of global generics at IMS Health, a healthcare information provider.
Israel's Teva, the world's biggest generic drugs maker, bought Germany's Ratiopharm in 2010 for 3.6 billion euros, while Mylan significantly expanded its global presence through its 2007 purchase of the generics business of Germany's Merck KGaA.
IMS expects annual global spending on medicines to rise by a quarter to nearly $1.2 trillion in 2016 from $956 billion in 2011. Global generic spending is forecast to almost double to $400-430 billion by 2016, from $242 billion in 2011.
While Germany's Stada is seeking deals to catch up with rivals, U.S.-based Par Pharmaceutical Cos Inc said last week that it had agreed to sell itself to private equity firm TPG for $1.9 billion following mounting investor pressure.
Industry analysts say that while deals can be a great way to cut costs and gain market share, small companies can often better compete by turning their smallness into an advantage.
Specializing in niche therapeutic areas can protect small companies from sliding prices if, for example, they pick markets with high entry barriers such as injectable drugs, women's healthcare and psychiatric disorders.
"It is a lot harder, more expensive and needs more technical competence to make an injectable product with ampules, than an oral pill," Jefferies analyst James Vane-Tempest said.
"So when you are thinking of competition from some of the new market players, then if you are in a segment that is hard to manufacture, there will be fewer competitors," he added.
Makers of injectable drugs also benefit because hospitals, the biggest buyers of these products, are facing supply shortages as many big companies have stopped producing these low-margin products. Focusing on one therapeutic area also has marketing benefits.
Companies that offer only injectable drugs, rather than a full range of medicines, can still negotiate good prices with hospitals, said Christoph Bieri, an adviser with Turkey-based M&A consultancy firm IMAP.
U.S.-based Hospira Inc and Germany's Fresenius SE & Co's generic unit, Kabi, have built successful businesses by specializing in injectables.
Expertise in injectables could also help when the market for biosimilars, or copycat biotechnology drugs, opens up.
Biotechnology medicines are usually administered by injection or infusion, and once U.S. and European regulators iron out the creases in the regulatory pathway for biosimilars, this could open up big opportunities for these companies.
Psychiatric disorders and women's health are two other areas that have sizeable, yet not highly commoditized, markets -- a promising environment for a mid-sized generic drugmaker.
"In psychiatric disorders like schizophrenia and depression, patients have to take the drugs for a very long time. These drugs interfere with each other and each formulation," IMAP's Bieri said. "So if you get a psychiatric doctor to prescribe your generic in the beginning, there is a high probability that the patient will stay on that generic even if there is a cheaper alternative found on the market."
Differentiation is also crucial to cushioning margins when similar drugs are competing on price, and improved generics, popularly known as super generics, that offer added benefits can command a higher price.
Super generics are essentially tweaked versions of branded drugs that offer advantages over usual copycat drugs, such as Teva's generic version of Bristol-Myers Squibb Co's widely used cancer drug Taxol.
"We have some markets for improved generics, which have a slightly different formulation, so you can digest it better. They taste nicer, they look nicer, they have better packaging and higher compliance," Bieri said.
Focusing on dominating one market for specific drugs can help small players, as shown by Britain's Mercury Pharma, which was taken private by private equity firm HgCapital in 2009.
"Mercury has a number of products that are either difficult to make or have very low prices but high volumes; but only in the United Kingdom. This kind of approach could be a big potential for smaller players," IMS's Sheppard said.
The emergence of newer drug markets in the developing world have also been talked up as a growth opportunity, but one that may not always be suitable for the smaller companies.
China, India, Brazil and other emerging markets are expected to contribute 28 percent of global spending on medicines by 2015, up from 12 percent in 2005, according to IMS Health.
But while the headline number is big, the individual country markets are fragmented.
"It is going to be a different patient, a different consumer, a different regulatory environment, a different distribution network (in each market)," said David Blumberg, an adviser with audit and advisory firm KPMG.
"Is a small company really ready to tackle all that?"
Editing by Rodney Joyce and Ted Kerr