Pharmaceuticals in China: So long, easy money

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    China is already the world’s third-biggest market, behind only America and Japan, and is likely to consume $75 billion-worth of medicines this year. Sales have been growing at a compound annual rate of nearly 25% since 2009. Rising incomes and rapid ageing mean that demand for drugs should continue soaring. The expansion of publicly funded health insurance should also, in theory, bolster demand.

    However, as Bain points out, foreign drugmakers now make most of their profits not from new products still under patent, but from branded medicines whose patents have expired. In America such older drugs have tiny margins because of the fierce competition from makers of unbranded “generic” copies. In China the off-patent medicines are highly profitable, partly because locally made generic versions are of poor quality. Alas for the foreign drugmakers, reforms under way are likely to trigger a slump in sales of their lucrative off-patent drugs.

    One reform aims to remove some perverse incentives in the health system. The peddling of overpriced pills has long lined the pockets of underpaid doctors and padded the profits of underfunded hospitals. Selling drugs to patients at a markup, especially foreign firms’ branded, off-patent ones, provides 40% of Chinese hospitals’ revenues and nearly all their profits. Now, officials are instituting a “zero markup” policy on drugs at hospitals, and cracking down on unnecessary prescriptions. They are pushing to improve the quality of Chinese-made generics, thus taking away the justification for the price premium enjoyed by foreign branded drugs.

    Even the expansion of state health insurance, which will soon cover nearly everyone in China, is not the good news it seems for drugs firms. The government will become a near-monopsony buyer, and is determined to use the power this brings, as well as explicit price controls, to rein in the cost of all but the most innovative treatments.

    Another reform that will hit foreign drug firms is President Xi Jinping’s anti-corruption drive. GlaxoSmithKline, a British firm, has been accused by Chinese officials of orchestrating “massive and systemic bribery” to get doctors and hospitals to overpay and overprescribe. The firm, which acknowledges local employees acted outside its “processes and controls”, has suffered a sharp drop in sales in China. With investigations into other foreign firms rumoured to be under way, the freewheeling marketing practices that have propped up the industry’s business model in China surely cannot last.

    As demand for branded medicines has boomed in recent years, the foreign drug firms have recruited armies of sales reps to sweet-talk doctors and hospital bosses: their numbers almost trebled between 2008 and 2012. If they do not make drastic cuts in the cost of this sales force, in line with the expected slump in demand for the medicines they are peddling, Bain reckons the foreign firms’ Chinese profits could vanish entirely in five to seven years.

    There is a ray of hope for the longer term, though. The Chinese authorities are moving to clarify and speed up the hitherto murky procedures to win approval for new medicines. It is uncertain how big or profitable the market for such patented drugs will be, because the government’s reimbursement policies are not yet clear. But Bain expects that growing demand for them will help to limit the foreign firms’ loss of market share to local generics firms.

    That said, it will be much harder work than peddling old pills. Having spent a fortune to develop the new drugs, firms will then have the further cost of educating doctors and hospitals about their benefits, which will require a more skilled sales force. Although the Chinese market still looks a promising one for the longer term, the foreign drugmakers face a severe squeeze in the next few years, and not all of them may be able to withstand it.




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