Secondary sales belong in the board pack

Indian pharmaceutical companies sell most of their domestic medicines through a long chain. Goods leave our Baddi plant for carrying and forwarding agents, who hold them on our behalf in each state. Stockists buy from those agents and supply retail chemists and hospital pharmacies, and a chemist finally sells to a patient with a prescription. Under Ind AS we recognise revenue when control passes to the stockist. That is correct accounting. It is also, in my experience, the commonest way in which an Indian branded business can look healthier than it is.

The reason is not complicated. Between our invoice and the patient's purchase sits inventory we no longer own but still depend on. If stockists hold a little more of it each quarter, reported revenue grows faster than the medicine is being used. Eventually that inventory sells, or expires and comes back to us, or forces a run of smaller orders. Nothing here is concealed. It is simply absent from the numbers most boards are shown.

Revenue that sits in a stockist's godown

In mid-2022 our stockists were holding 46 days of Meruvel's domestic inventory. Their own sales to chemists justified perhaps 25 to 30. The extra fortnight had not arrived by accident. For years our quarters had closed with schemes: additional free goods for orders above a threshold, longer credit for stockists who took a full month's supply in the final week. Each scheme was approved, documented and recorded correctly. Together they meant that about a fortnight of future demand had been sold early and booked as revenue.

The costs appeared elsewhere. Expired stock returned to us cost ₹38 crore a year, a figure that sat in a provision and was rarely discussed beside the revenue that created it. Stockists carrying more of our stock took longer to pay, and receivable days had drifted to 52. The interest cost of that credit appeared in finance costs, not in the domestic business's results, so the people who created it never saw it.

Price control makes the temptation stronger. A large part of the Indian market falls under the Drugs (Prices Control) Order. Scheduled formulations carry ceiling prices that India's National Pharmaceutical Pricing Authority notifies and revises, and other products face a limit on how far their maximum retail price may rise in a year. I support the purpose of those rules. Their consequence for management is that price rarely rescues a weak quarter, so volume becomes the lever, and the quickest volume to produce is primary volume. A domestic business working under price control and quarterly pressure will drift towards loading the channel unless someone measures the drift.

The incentive is the accounting policy

When we decided to correct this, the hardest part was not the accounting. It was the incentive plan. Our 2,150 medical representatives and their managers were paid on primary sales in their territories. As long as that remained true, every quarter-end would produce a push, whatever policy finance wrote. The incentive scheme was, in practice, our revenue-recognition policy for the channel.

We moved incentives to secondary sales: what stockists sold on to chemists, measured through stockist data. That sounds cleaner than it was. Secondary data in India comes from stockists' own billing systems, gathered through a mixture of direct feeds and data aggregators, and it is patchy in smaller towns. For the first two quarters some representatives were paid on numbers they did not trust, and some of them were right not to. We audited a sample of stockists each month, reconciled their reported stock with our dispatches and published the error rate to the field force. Trust returned slowly, and it returned because the error rate fell, not because we asked for it.

The commercial cost was real. Primary sales fell by ₹88 crore in the July to September quarter of 2022. Our domestic revenue grew 1 per cent that year while the market grew faster. About 140 smaller stockists stopped dealing with us, mostly in district towns where credit mattered more than our terms, and some prescribers there moved to brands that stayed on the shelf. The president of our India business had predicted each of these effects. He was right, and the board still preferred a smaller, truer number.

Four numbers for the board

Since then, every quarterly board pack has carried four measures beside reported domestic revenue. I would recommend them to any Indian branded business, and to any independent director trying to judge one.

The first is secondary sales growth set against primary sales growth for the same period. When the two diverge for more than a quarter or two, a director should ask why. The second is stockist inventory in days of secondary sales, shown by region, because a national average can hide one state where a regional manager has been unusually persuasive. The third is expiry and breakage returns as a share of sales, which is the channel's delayed verdict on what was pushed into it. The fourth is stockist receivable days, which tells the board whether growth is being bought with credit.

None of these measures is perfect. Secondary data are estimates and should be labelled as such. They do not replace independent prescription and retail audits, which show whether doctors are writing our brands and chemists are dispensing them, and they say nothing about market share. But they turn a conversation about revenue into a conversation about demand, and that is the conversation a board needs to have.

The results since 2022 have been encouraging rather than dramatic. Stockist inventory reached 29 days by March 2023 and has stayed close to that level. Expiry returns fell to ₹14 crore by 2025–26, receivable days to 34, and secondary sales have grown at about 11 per cent a year from 2023–24 to 2025–26. Domestic revenue reached ₹1,070 crore. That growth is slower than the channel could have shown in a good year of schemes, but each rupee of it now corresponds to a medicine a patient has bought or is about to buy.

I do not think this is a matter for finance alone, and I do not think channel loading is usually dishonest. It is what a sales organisation does when it is paid on primary sales and judged on quarters. The remedy is to change what is measured and what is paid, and then to show the board both numbers until nobody needs reminding why they differ.