Bitter pill

Foreign pharmaceutical firms are finding it tough going in China

A customer shops at a pharmacy in Xuchang

Drug wars: Hunan leads the way in ratcheting down prices

R&D in Chinese medicine has taken some twists and turns throughout the country’s history, not least in the middle of the ninth century. That’s when alchemists experimenting with an elixir for eternal life discovered that a mixture of saltpeter, sulphur and carbon had far deadlier properties. Drinking it proved to be inadvisable. But wrapping it around an arrow and firing it at an invading army turned out to be a highly effective. Gunpowder was born.

More recently, Chinese pharmaceutical companies have been increasing their R&D spending in an attempt to move up the value chain from the production of generic drugs towards first-to-market ones. The goal? To compete with the foreign firms that still dominate in China, and then to export more homegrown drugs into international markets.

Such moves may also help to counter local pricing pressures, which have become evident in the latest government tenders. (Any pharma company hoping to sell drugs to public hospitals in China is required to participate in mandatory tenders organised by each provincial government.)

During the former round of tenders in 2009 and 2010, price cuts had a detrimental impact on the stock prices of local firms in the sector, which fell by roughly a third before starting to recover again at the beginning of 2012.

In recent weeks, history looked as if it might be about to repeat itself after Hunan’s provincial government released its tender results.

Share prices slid by about 5% over the space of two days when it became clear that the province had forced companies into price cuts of between 10% to 50%. Hunan’s process triggered heated price negotiations. For rarer drug types or classes (i.e. where there are three competitors or less) this led to average price cuts of 11%. The fall was even more pronounced (19%) in categories where more than three competitors made a similar drug.

Shanxi province has since said it is considering the same process, while Hubei, Shanghai and Tianjin have gone one stage further. They are introducing second round negotiations, which will enable public hospitals to continue to bargain with drug suppliers, potentially forcing them to drop prices yet again below the winning tender bid.

So far about one third of China’s provinces and major cities have completed their tenders, with the rest scheduled to do so by June.

Domestic newspapers point out that foreign pharmaceutical companies have been the hardest hit so far. The Economic Observer reports that many foreign firms simply abandoned bidding in Hunan when it became clear prices were heading lower. “We expected prices to come down a bit, but never thought the decline would be so steep,” a middle manager at one foreign pharma firm tells the newspaper. “It wasn’t cost effective to supply drugs at those kinds of levels, so we withdrew from the process.”

According to the same newspaper, Bayer bid for 36 drug classes, but won only nine (with a worst-case price cut of 11%). Astrazeneca bid for 24 classes and won 13, with a maximum price hit of 14%. Eli Lilly, Merck and Pfizer had to stomach price declines of 32%, 39.8% and 55% respectively in their worst tender results.

Their domestic counterparts had to cut prices as well. But this was offset somewhat by an increase in market share thanks to the foreign retreat. Local players have also introduced some of the newer drugs they have been developing.

Sinopharm, for example, won 34 tenders in 2015 compared to 18 in 2010, with the steepest price decline coming in at 18%. Fosun won 21 this time round compared to 16 in 2010 and cut prices by a maximum of 4%. Hengrui won 34 bids up from 12 in 2010 and cut prices by a maximum of 10%.

As one domestic industry source explains to the Economic Observer, “Foreign companies gave up, but domestic companies are used to low margins. As long as they can survive, they’re prepared to continue supplying the market.”

With gross margins averaging 46%, China’s larger local firms are hardly struggling and have also been investing heavily in R&D to protect and expand their margins in future. One of the largest, Hengrui, now has 1,400 R&D staff, 30% more than its rival Humanwell.

The company currently spends 9% of annual sales on R&D and has been able to capture 9.7% of the domestic cancer drugs market, second only to Roche’s 14%. It has also been emulating Hua Hai Pharmaceutical’s push overseas and recently acquired US Food and Drug Administration (FDA) approval for its cancer drug cyclophosphamide. Analysts believe it may break the long-term hold on that market of the US healthcare firm, Baxter International.

Likewise, Hua Hai Pharmaceutical has seen sales of its epilepsy medicine Lamotrigine soar since it was launched in the US in 2012. The drug now accounts for 20% of total sales.

Hua Hai has been able to push itself up the value chain by moving away from supplying API drugs (Active Pharmaceutical Ingredients) to exporting fully finished products.

Since 2010, the world’s pharmaceutical giants have lost the exclusive rights to many of their blockbuster drugs because of patent expiry. Their response has been to speed up the time-to-market cycle for new drugs and restructure their operations by selling off non-core assets. Last month, for instance, Novartis and GlaxoSmithKline won EU approval for a trade swap of the former’s vaccination business for the latter’s cancer drugs operation.

The Paper, an internet newspaper, believes Chinese pharmaceutical companies can take advantage of some of the pullback by the foreign firms. Late last year, Bristol-Myers Squibb made 1,000 people redundant in China; meanwhile Merck is unwinding its local joint venture, with the loss of 400 out of 700 jobs. There are reports that Eli Lilly and Bayer may shed more staff too.

Meanwhile, Chinese firms have been on a hiring spree. Grand Pharma has set up a direct sales division, while Shineway is recruiting up to 200 people for its sales network, with a preference for staff trained by foreign firms. The Paper cites the case of Li Hui, who was laid off by Bristol-Myers Squibb in December. Li has since received job offers from four other local companies at twice his previous salary.

The Economic Observer also says that domestic pharma companies may benefit from a policy switch favouring greater usage of local treatment for serious illnesses. This means patients from tier-two and tier-three cities will now receive care from prefecture-level hospitals where domestic pharmaceutical firms are prevalent (with a market share of 70% to 80%).

Foreign pharmaceutical companies are more likely to have the upper hand in the elite hospitals in the bigger cities.

More M&A among domestic players may also be on the cards as China tries to increase its healthcare spending as a percentage of GDP from 5.5% to 7% by 2020. The US, by contrast, is hoping to head in the opposite direction. At 18% of GDP, its health spending is higher than any other nation. Many of the system’s critics blame rules which prevent the federal government from intervening in drug prices.

For example, the FDA only has to rule whether a drug is safe and not whether it is too expensive. US insurance companies decide the latter – but do not have a strong track record of controlling prices.

Pharma companies counter that they need their bumper US profits to fund the next round of drug research. This practice has to stop, Steve Miller, the chief medical officer at Express Scripts, one of America’s largest benefits managers, tells the Financial Times. “The US worker is being gouged to fund innovation for everyone,” he complains. “America can no longer be solely responsible for all of pharma’s profits.”

But as Hunan’s tender indicates, the Chinese are not making his job any easier.

© ChinTell Ltd. All rights reserved.

Sponsored by HSBC.

The Week in China website and the weekly magazine publications are owned and maintained by ChinTell Limited, Hong Kong. Neither HSBC nor any member of the HSBC group of companies ("HSBC") endorses the contents and/or is involved in selecting, creating or editing the contents of the Week in China website or the Week in China magazine. The views expressed in these publications are solely the views of ChinTell Limited and do not necessarily reflect the views or investment ideas of HSBC. No responsibility will therefore be assumed by HSBC for the contents of these publications or for the errors or omissions therein.