Deloitte: Multinational Pharmaceutical Enterprises are in Deep Waters in China

Deloitte has recently issued a report New Healthcare Reform in a New Era--Challenges for Multinational Pharmaceutical Companies and Corresponding Countermeasures to be taken to analyze the 5 challenges of multinational pharmaceutical companies in China. The pharmaceutical industry, as a pillar industry that will fuel economic growth in the future, is expected to maintain medium to high growth rates during China’s 13th Five-Year Plan period. Several factors are likely to jointly increase the consumption demand for medicine in China, including: the increase in resident income, the upgrading of consumption structure, the accelerated population aging process and urbanization, the implementation of the Healthy China strategy as well as further improvements in China’s medical insurance system. Meanwhile, other factors, including the need for medical cost controlling, the complicated ecosystem of the medical and pharmaceutical industry and China’s reinforced supervision over business compliance, will bring challenges for multinational pharmaceutical companies (MPCs).

Fig. 1 Top 10 MPCs’ Market Performance in China in 2015

Growth has slowed down

According to data from Sinohealth CMH, the total sales volume of MPCs across five terminals amounted to about RMB 312 billion in 2015, representing 22.7% of market share. Furthermore, a year-on-year growth rate of 7.1% was recorded, representing a drop of 5.3% compared to 2014. Among the top 10 MPCs, the year-on-year growth rate of GSK continues its slide.

Original drugs have lost the advantage of high premium

MPCs’ profits are mainly generated by their original drugs (i.e. imported drugs that are off-patent), which are eligible for separate pricing, being sold at prices several times or dozens of times higher than Chinese generic drugs. The Chinese government has been committed to lowering pharmaceutical product prices, trying to control pharmaceutical product costs through a more rigorous tender process, which will certainly result in impacts on high premium original drugs.

In the second half of 2015, increased pressure on the "price ceiling" at the tender stage forced most MPCs to substantially lower their prices. Since most provincial tenders referred to China’s national minimum-winning bid, companies hesitated to adopt low price strategies. Moreover, the Chinese government has launched an evaluation of generic drugs’ consistency in 2015, meaning that generic drugs that have passed the evaluation can theoretically take part in the bidding process alongside original drugs, resulting in further decrease of original drugs’ profit margins.

Over the past decade, original drugs experienced rapid growth, partly owing to a favorable government policy. However, decreasing pharmaceutical product prices and strict regulation will make it difficult for original drugs to maintain the original high premium. MPCs’ original model of making huge profits by depending on original drugs cannot be continued.

 "Reducing prices for market" negotiations have failed to achieve desired results

In addition to centralized tenders, the Chinese government has organized national price negotiations with regard to certain expensive pharmaceutical products. However, during the implementation process, achieving "reducing prices for market" turned out to be easier said than done. As of December 23, 2016, only 23 provinces had included the negotiated pharmaceutical products in the scope of various medical insurance compliance expenses. Different management structures over the medical insurance system make it difficult to achieve agreement over drug price negotiations and medical insurance: while the National Health and Family Planning Commission of the P.R.C. leads the drug price negotiations, it is up to the Ministry of Human Resources and Social Security of the P.R.C. to decide if the drugs can be included in the medical insurance system; furthermore, the fundraising capacity varies from province to province. However, the reason for MPCs to accept a considerable cut in their profit margin is largely because of the expectation for an inclusion of their pharmaceutical products in the medical insurance system, hoping for an increase in sales that can potentially compensate the effects of the price reduction; but if the sales do not reach expectations after the price reduction, this will impact their profits.

In the Notice on Determining the Negotiating Range of Medicines List for National Basic Medical Insurance, Work-Related Injury Insurance and Maternity Insurance in 2017 issued by the Ministry of Human Resources and Social Security of the P.R.C. on April 14, 44 varieties are included in the negotiating range, including 26 imported varieties and 18 Chinese varieties. Seen from products entering the negotiating range, the proportion of Chinese varieties has exceeded expectations. The increase of the number of Chinese varieties selected shows China’s strong support for Chinese innovative drugs.

Looming trend towards replacement of imported drugs with Chinese drugs

Prices of most Chinese drugs are significantly lower than the ones of imported drugs. Against the background of stricter cost controls, many regions are encouraging the use of less expensive Chinese generic drugs over imported original and generic drugs, to lower medical expenditure and medical insurance costs.

On the one hand, to reduce doctors’ prescriptions of expensive medicine or more medicine, which had resulted from a malfunctioning incentive mechanism for medical institutions, the General Office of the State Council of China published the Guiding Opinions of the General Office of the State Council on Urban Public Hospital Comprehensive Reform Pilot in May 2015, with the aim to lower the percentage of medicine sales in revenue of pilot public city-level hospitals to around 30% by 2017. This measure will first have an impact on sales of the relatively expensive imported drugs.

On the other hand, the pilot scope of the reform of the payment method, i.e. payment according to DRGs (Diagnosis Related Groups), is expanding. The implementation of the new payment method will radically restrain hospitals from prescribing expensive medicine, and will further encourage medical institutions to use Chinese products with similar curative effects but lower prices.

All these abovementioned measures are likely to restrict hospitals’ use of expensive original drugs and drive doctors to Chinese generic drugs that are more cost-effective. However, compared to prices, quality of generic drugs is also a very important influencing factor. Therefore, the Chinese government is taking multi-pronged approaches to enhance the competitiveness of Chinese pharmaceutical companies as well as to improve the quality of Chinese generic drugs by adopting consistency evaluation and a new edition of GMP. Thus, the quality difference between products of Chinese pharmaceutical companies and those of MPCs will gradually be reduced.

Operating pressure pushes pharmaceutical companies to adjust their business arrangements

As a result of a series of Chinese government policies including strict control of drug prices and cancellation of drug mark-up, etc., MPCs’ drug prices have significantly decreased and their market shares have also declined. Due to the high cost structure of MPCs, keeping all low-profit projects is not conductive to own transformation. Therefore, many MPCs with broad market arrangements and numerous product lines have started to review their current products, sell or reduce weaker internal product lines and reinforce and strengthen competitive products and markets. For instance, Bristol-Myers Squibb – under its mature product life cycle management strategy – has successively divested its diabetes, tumor and cardiovascular departments, etc., using a cost control approach to increase its profits. Bristol-Myers Squibb has shifted its focus to the core business of biological and innovative medicines under the operating pressure.

Fig 2. Bristol-Myers Squibb Conducted Business Adjustment in 2016

Under the pressure of patent cliff and drug price reductions, many MPCs have begun to focus on their dominant business and to transfer rights to sell their mature pharmaceutical products. In 2016, many international pharmaceutical giants including Bayer, AstraZeneca, Novartis, GSK and Eli Lilly, etc. transferred business to Chinese pharmaceutical companies.

As the medical reform progresses, MPCs are facing an increasingly challenging environment. From the policy perspective, policies for the pharmaceutical industry are gradually tighter, with cost control and industry norms becoming the focus of medical reform. Cost control puts continual pressure on MPCs’ profit rates. MPCs will also benefit from a more standardized industry environment with the medical reform going deep. Furthermore, the rigid market demand caused by an ageing society and urbanization, etc. will drive the industry to steadily grow, and the multi-dimensional policies will ensure healthy growth of the market.

How can MPCs succeed under the new situation in China? Firstly, conduct localized production and R&D; secondly, shift down market and arrange grassroots medical care; thirdly, build overall solutions, and explore new business models of "Internet+" and cooperation with insurance companies, etc.