For pharmaceutical companies in China, today is a very exciting time, but also a highly challenging one. Thanks to a rapidly rising economy (GDP growing over 11% in 2006) and newly prosperous citizens wanting better healthcare, the pharmaceutical market there is growing quickly, at about 15% per year. In 2010, some experts predict that China will be the fifth-largest drug market in the world.
However, due to demographic and regulatory changes, the market’s structure and incentives are shifting rapidly. Some Chinese drug manufacturers are going out of business, while others are changing just to survive. Foreign drug companies continue to have many market advantages for their high-end products, but they will also need to move rapidly to keep this position.
Current Market Structure
The following are the main features of China’s current drug market:
(a) HOSPITAL-BASED. 63% of all drug sales are in hospitals. In general, the bigger the hospital, the greater the per-patient spending.
(b) HEAVILY URBAN. Per capita health expenditure in urban areas is 3.5 times what it is in rural areas. Traditionally, it is also oriented toward the biggest cities – more than one-third of hospital drug sales are in the top 16 cities alone. Multinational corporations (MNCs) have a much greater focus on these cities, due to higher income levels there.
(c) BASED ON SELF-PAY: Although some medical expenses are paid by employers, government, and others, more than 50% still come out-of-pocket. Currently, private health insurance plans almost exclusively cover inpatient care, not prescriptions.
(d) OFTEN BIASED TOWARD MORE EXPENSIVE DRUGS FOR PATIENTS WHO CAN AFFORD THEM: Although most hospitals are state-owned, a large part of their operating revenue comes from the sale of drugs through in-house pharmacies. Chinese hospitals today are only permitted to mark up a drug’s consumer price to 15% over their purchase price.
Multinational Versus Domestic Firms
Twelve of the top 20 drug firms in the Chinese hospital market are foreign MNCs, which have a favorable market environment in China for many reasons. Their core advantage is that they have distinguishable, innovative, sought-after products. MNCs are experiencing an average sales growth of about 25%, compared to 15% for the market as a whole. Some key money-making areas for them are cardiovascular health, diabetes, and cancer.
MNCs also often have highly-trained sales forces and good relationships with key opinion leaders (KOLs). On average, MNC drug companies spend $200,000 annually on sales force education and training, compared to $50,000 spent by domestic drug firms.
The characteristics of domestic Chinese drug firms are more varied, but they are almost all generic companies. They dominate the local active pharmaceutical ingredient (API) and over-the-counter (OTC) markets, but not the prescription markets. There are both large companies and vast numbers of small-to-medium Chinese manufacturers and distributors across the country. Many of these Chinese companies, as well as some larger ones, are suffering from low profit margins and bad debt.
Regional Demographic Shifts
As mentioned above, more than one-third of China hospital drug sales are in the top 16 cities today. However, this figure was almost half in 2000. The reason for the decline is that the major coastal cities (Beijing, Shanghai, Guangzhou, etc.) are becoming less economically dominant. As wages rise, many industries are relocating to less-developed “second-tier” cities (Suzhou, Wuhan, Chengdu, etc.). This process is kick-starting economic performance and living standards, leading to increasing numbers of drug consumers in more and more areas of China.
Because many second-tier cities are further inland than other major cities, drug consumers are now more geographically diverse. In response, Western manufacturers may need to find distributors for more Chinese regions. If they have their own sales force, they may need to expand their geographical coverage.
Giving kickbacks to hospitals and other purchasers is common in the Chinese domestic drug industry. Some domestic firms have essentially based their sales strategy around it, with sizable budgets for “relationship management.” Others, including some foreign drug companies, rely on distributors or independent sales agents to do this for them. However, using kickbacks is not an ideal long-term way of doing business in China due to the government’s new efforts to eliminate them.
Previously, there was no effective sanction for corrupt practices. However, due to public outcry over deaths caused by faulty drugs, the government is currently cracking down. It went as far as executing its own top drug regulator at the State Food and Drug Administration, Zheng Xiaoyu, for corruption in July 2007. Many businessmen have also been arrested by stepped-up enforcement, causing concern in the domestic industry. Some large domestic drug companies are now actively formulating long-term strategy shifts that will make them much less reliant on kickbacks and similar practices. MNCs generally have better systems of Western ethics in place already; in addition, they have less need to give kickbacks, due to their unique products.
Drug Reimbursement Issues
Products on the National Reimbursement Drug List (NRDL) commonly have a significant advantage over other drugs that are not on the list. It is true, as mentioned above, that much medical care is paid for on a self-pay basis in the Chinese market. However, for patients in the Basic Medical Insurance (BMI) system (about 180 million, most of urban residents), the government reimburses 70-90% of the cost of drugs listed in the NDRL.1 This leads to patients preferring, or even demanding, a listed drug over others that could be prescribed.
The NDRL is theoretically revised every two years, but the last revision was four years ago, in 2004. Also, if BMI patients exhaust their “Individual Account” (an account dedicated to outpatient expenses, co-pays, and drug costs), the patient must pay all drug costs out of pocket, without reimbursement.
Typically, when a drug is put on the NDRL, generic competition intensifies. The NDRC also tends to issue price cuts to help control government spending on reimbursement. Together, these processes push down the price over time. It should be noted though that there is still a niche for more expensive original-brand drugs (mostly from MNCs) on the Chinese market, even when there is generic competition. This is because the NDRL lists drugs based on their active ingredient, regardless of price. Therefore, original-brand products receive the same reimbursement as a percentage of price, even though the price may be three to five times higher. Urban hospitals commonly stock them alongside generics for the patients who can afford them.
Possible future reforms to the NDRL include: (1) liberalizing the process of listing drugs for reimbursement; (2) reimbursing based on a generic price (not as a percentage of the actual price, regardless of how high it is); and (3) limiting annual drug reimbursement per patient. These would have different impacts on the industry. Liberalizing the entry of drugs onto the reimbursement list would help the producers of newly-entering drugs, domestic and foreign. On the other hand, reducing reimbursement of more expensive listed drugs would remove some of the incentive for hospitals to buy them. Still, in general, wealthier consumers should continue to prefer foreign drugs for their quality.
Hospital Purchasing Issues
Another important change to the drug market in China is greater hospital tendering. More and more, large hospitals are forming purchasing networks to combine their purchasing power. For example, in 2006, the tendering system in Guangdong province (China’s largest hospital-drug market on a provincial basis) was able to cut drug prices by an average of 30%. The processes governing hospitals tenders are also becoming somewhat more transparent. Depending on the system, bidding prices are often made public, and more tendering systems are also now conducted online. This allows greater access to new entrants with fewer connections.
Currently, hospitals tend to stock one original brand and a few generic brands. However, the recent Ministry of Health (MOH) Order 53, Measures for Prescription Management, restricted them to stocking no more than two brands of any chemical substance. In response, hospitals are expected to reduce their stocks to one original brand and one generic brand only. This will put even more pressure on generic prices, since generic manufacturers will have to compete for one slot instead of two.
Healthcare Reform Prospects
In the longer term, some kind of broad reform to China’s healthcare system is likely. Some elements of reform under debate include the following:
• A shift from large hospitals to smaller community medical institutions to deliver major care;
• Standardization of outpatient fees and total inpatient fees;
• Allowing the NDRC to set prices for most drugs as soon as they come on the market (except patented drugs; for these, the NDRC would merely reserve the right to intervene in pricing).
Even if none of these come about, the government is already expanding membership in the existing public healthcare insurance systems. It plans, very optimistically, to cover all of China by 2010. There is also a good deal of public enthusiasm for the idea of eliminating the mark-ups hospitals charge on drugs altogether. This would remove a large cause of the Chinese medical system’s bias toward more expensive drugs. However, it would be extremely difficult to achieve politically unless a new source of hospital income is found to make up the resulting deficits.
The drug industry in China is under significant price pressure from the various changes above (price cuts, stricter hospital tendering, possible reimbursement cuts, etc.), and should find this pressure rising over time. However, the government’s reform measures focus more on generic products than on original or patented products. MNCs’ sales growth is higher on average than domestic companies’ sales growth, and is likely to stay that way due to inherent advantages.
A major strategy domestic drug companies are taking to combat these pressures is differentiation of products. In a country with a fiercely competitive generic market, standing out in one way or another is understood to be a sales advantage. As a first step, many domestic companies are now marketing novel dose levels or combination products. Other practices include greater branding and marketing, engaging key opinion leaders, in-licensing patented drugs from MNCs, and even developing patented products themselves. At this stage, many of their patented products are Traditional Chinese Medicine (TCM) rather than Western medicine. However, that should change over time.
Opportunities for MNCs are also directly affected by the current trends. In particular, out-licensing a patented product to a Chinese drug firm was unthinkable in the past, due to intellectual property concerns. Today, out-licensing may at least be worth consideration.
In the long term, Chinese drug firms are being pressured by ongoing market and regulatory changes to become less focused on generics and more like global pharma, trading on differentiation, branding, and innovation. It will be difficult and time-consuming for them to restructure themselves to innovate. If they succeed, MNCs may find themselves with less of an inherent market advantage in China. However, for the time being, China is still an excellent destination for Western pharmaceuticals.
1. The NRDL is also used by the other major state-run medical insurance systems, including programs for rural residents (a system currently being expanded across the country), the military, and students.