Few sectors are more sophisticated in their view of the Chinese economy than
the Western pharmaceutical industry. Much of this sophistication is a
by-product of their realization very early into China's opening that it would
be a long time, if ever, before the industry could realize any cost advantages
as a result of exporting products from China and that, because product quality
is such an important factor for pharmaceutical materials, consumers would be
unlikely to trust Chinese-made medicines any time soon.
As a consequence, American and European pharmaceutical companies quickly came
to terms with China as a potential market, where most other firms saw China
initially as a source of low-cost production. Overall, multi-national
pharmaceuticals have been very early into the process of learning how to sell
and
market in the domestic Chinese market.
Pharma's success in these areas is no small feat. According to IMS Health,
China is on track to become the world's third largest pharmaceutical market by
2013.
In the first quarter of 2011, JPMorgan estimated that pharmaceutical sales
amounted to over US$5.3 billion for the top 10 American and European pharma
multinationals alone. Pfizer's domestic China sales are now approaching $1
billion a quarter, while Johnson & Johnson, a latecomer to the domestic
Chinese market, has sales approaching $300 million a quarter.
For most of the multinational companies in the JPMorgan report, the Chinese
market is growing around 30% year-over-year. Given the uncertainty surrounding
healthcare reform in the American market in particular, China remains one of
the bright spots for the pharmaceutical sector.
The greatest challenge facing pharmaceutical companies operating in China -
both multinationals and domestically owned firms - are changes to China's
healthcare payment process. With a rapidly aging population, the healthcare
sector in China is likely to be one of the most volatile growth markets for
companies; however, much remains unknown.
First, the government is still defining what it will pay for (which services
for particular disease states). Second, once China defines what it will pay for
a particular service, it puts very strict controls in place over how much it
will pay.
This has presented some unique challenges to pharmaceutical companies in China,
two of which were just fined by the central government this week over
allegations of price fixing on precursor materials needed for common blood
pressure medications.
In 2009, Beijing put forward the government's Essential Drug List (EDL), which
the October JP Morgan report stated would mean that "over three hundred Western
and Chinese medicines are expected to be sold at government-controlled prices".
Analysts at outside firms like JPMorgan and Citi have pointed out that this
presents a potential problem that could greatly reduce profit margins for both
domestic and multi-national pharmaceutical firms operating in China.
As the JPMorgan report emphasized, "With a reduction in price for
pharmaceutical companies whose products fall under the EDL, profit margins will
shrink while the exclusive rights to produce these drugs should theoretically
boost sales volumes." Some companies have suggested that even if they win
Chinese government contracts with lucrative volumes, their profit margins are
so poor that they will be unable to invest in developing new drugs.
Currently, price pressures have hit domestic Chinese pharmaceuticals the
hardest. At the same time as these companies struggle to meet Beijing's demands
on the pricing front, they are wrestling with the changing expectations from
their government in terms of the compliance standards to which they will be
held.
Stephen Sheng, the Asia Pacific Region Representative for Double Dragon
Consulting, a consulting firm that provides engineering, quality/regulatory,
and aseptic operations services for life sciences companies that must meet US
and European Union drug regulatory requirements, notes that "With the roll out
of the 2010 GMPs [good manufacturing practices] by the Chinese government, the
sFDA [China's equivalent of the US Food and Drug Administration] is sending a
loud and clear message to the pharmas in China that time is running out and
globalization is imminent."
China's domestic producers have certain advantages over their multi-national
peers: government sponsorship and home field advantage are just two. However,
they also face extremely sophisticated competition from established American
and European pharmaceutical companies that know how to play the complicated
game of managing government regulations in such a way as to maximize the
profitability of their businesses. Climbing the sFDA's hill is a challenge to
China's domestic producers but reflects an existing competency by their foreign
competitors.
Like many industries, the pharmaceutical sector is closely watching Beijing's
policy stance as healthcare reform presents both an incredible opportunity to
expand coverage to China's 1.3 billion under-served consumers, but also a
challenging market where rigid price controls and unclear government payment
practices remain significant challenges.
Both domestic Chinese and multinationals anticipate coverage will broaden and
reimbursement rates will grow, but multinationals in particular are keeping a
close eye on whether Beijing begins to ask them to transfer technology to
domestic partners as a trade for market access.
Given the public policy implications to making sure pharmaceutical products
remain accessible to China's population, these companies also face many of the
same challenges other high-tech firms in information technology and clean-tech
in particular are struggling with. Where the government believes its interests
do not align with those of private industry, it will likely move to protect its
own interests before considering what such adjustments signal to market
players. But in an increasingly saturated and mature Western healthcare market,
multinationals know they have to find a strategy for success in China.
For many Western pharmaceutical companies, while they may not be able to export
production of drugs from America to China, what they have found can be exported
is the research and development of new drugs from America to China. Faming
Zhang is the chief executive officer of Waterstone Pharmaceuticals, a company
that specializes in the outsourcing of clinical research and drug discovery
from the United States to China. He says that the decision to move research to
China is driven by "relatively cheaper talent pool and broad patient access".
In many ways, what Western pharmaceutical companies are finding as they work
with Chinese companies like Waterstone is that they can push forward with drug
discovery more cost effectively than they could in the West. This represents an
important challenge to advocates of globalization. Historically, the strongest
advocates for globalization have argued that the path forward for developed
economies is to move up the value chain into increasingly higher technology
work.
To watch as modern pharmaceuticals find they can access cost effective and
highly motivated workers in China is a challenge - as Howard Marks of Oaktree
Capital asked in remarks at last week's Asian Venture Capital Journal meeting
in Hong Kong, "where do the jobs come from in the West?"
While the answer to Marks' question today may not be clear, what is coming into
focus is that China's strategy of moving up the value chain into higher
technology sectors like pharma is reaping early benefits that both benefit
multinationals and further refine the model for how the American and Chinese
economies can work together in the 21st century.
As can be imagined, the sort of relationship companies like Waterstone have
with their multinational customers is not absent risks for both parties.
Multinationals in particular realize that their intellectual property (IP) risk
must be properly managed under such an arrangement, but Zhang believes that
"the higher IP risk in China is more of a perception".
Zhang advocates that Western companies have "strict contracts with Chinese
partner, and always have active patent protection. Like many of Waterstone's
competitors, these new Chinese-based drug-discovery firms that serve large
multinational pharmaceutical companies are usually founded, capitalized and
managed by Chinese-born, Western-educated managers who worked at a Western
pharmaceutical company before starting their business.
Along these lines, some US-based pharmaceutical start-ups are also evaluating
China with an eye towards lower cost drug discovery, clinical trials and, in
some rare cases, capital for their company. According to Zhang, many of these
early-stage pharmas have a "China connection", but he cautioned that Chinese
capital can bring with it some challenges. Specifically, "the demonstration of
profitability within less than five years, because Chinese investors look at
short-term return more importantly [than long-term]."
Few industries encompass the challenges and opportunities within the Chinese
market as broadly as pharma. The needs for basic drugs to treat diabetes, heart
disease, vaccines and other conditions that Americans take for granted as
highly treatable conditions remain significant problems in China. This is the
great opportunity that drives multinationals as they expand within the country.
Yet, China's market is heavily reliant on government sponsorship. In China,
such sponsorship traditionally comes with heavy obligations felt at a minimum
through price controls and, in many of the extreme cases where Beijing's
domestic policy considerations take a front seat, in the form of government
forcing technology transfer.
Benjamin A Shobert is the managing director of Teleos Inc
(www.teleos-inc.com), a consulting firm dedicated to helping Asian businesses
bring innovative technologies into the North American market.
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