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Pharma's Wild Ride In China
What a year it was for pharmaceutical multinationals working in China. Everyone must surely be familiar by now with GSK’s twin sagas that unfolded over the summer involving bribery allegations and problems with its Chinese-run clinical trials. Both issues threw open the doors on long-standing problems in China’s healthcare economy. The problem with corruption? Certainly not news. The problem with under-compensated doctors and hospital administrators starved of reimbursement? One of the longest and most persistent problems in China’s healthcare system: without a doubt, not news. The problems specific to drug discovery and clinical trials in China? Definitely not surprising given how quickly China is building out these capacities. Foreign companies being held to different standards than their domestic Chinese competitors? If only that was news.
So what exactly made the GSK scandal such a big story? Because it indirectly draws attention to one of the foundational but increasingly tenuous assumptions that has sustained the valuation of publicly held pharmaceutical firms: market access and revenue growth opportunities in China will offset the underwhelming drug pipeline, maturing patents and price pressures MNCs are experiencing in their home markets. To say it more simply: China was supposed to be the answer to most of the problems MNCs were going through in the developed world.
As 2014 gets started, it is a good time to reflect on what the pharmaceutical industry has learned in China over the last several years. First, the political contours of healthcare in China have become clearer. Healthcare is politically sensitive in China, as it is in any country; however, China’s policy makers showed a willingness to make a political point at the expense of a multinational company, whose alleged guilt comes up well short of how domestic Chinese companies conduct themselves on a day-to-day basis. Because the Chinese state has controlled and dominated healthcare delivery, frustrations over inadequate access, out of control costs born by the consumer, and poor quality are problems the government has created.
Every year, across China, thousands of incidents of violence against doctors and healthcare workers occur, a reflection of the anger people feel about healthcare inequality. China’s central government understands this all too well, and needs to redirect public frustration elsewhere. This makes it easy to pin the blame for high prices on companies like GSK that are alleged to have paid bribes to doctors for artificially inflating drug fees by 30% or more. Never mind that these habits evolved over years and reflect basic problems with how little doctors are paid and how grossly under-resourced Chinese hospitals remain because of government policies. Life science companies heavily reliant on China for growth need to understand the basic risk they face: the more the country strains to expand healthcare services and the more public resentment over inadequate healthcare access persists, the more likely the Chinese government will be to try and re-direct public frustrations away from policy makers and towards private, for-profit entities.
The second lesson pharmaceutical and device companies have had reinforced in 2013 is the extent the Chinese government will go to attach conditions on market access. What the 12th Five Year Plan laid out as an objective, the events of 2013 have made more clear: China wants to develop a domestic life science sector, and is going to work to connect access to its domestic market with technology transfer programs between MNCs and Chinese research institutions or industry partners. Basic questions about whether existing WTO protocols, or forums like the Strategic and Economic Dialogue (SED), are now being asked.
Whether these venues are sophisticated or forward-thinking enough to capture the unique needs of life science companies is uncertain. These businesses understandably fear they will be put in a situation to empower Chinese competitors without adequate safeguards to their own global R&D investments, simply as a “cost” of doing business in China. The industry has known for some time that global R&D spending on drug discovery was going to re-balance, with China speaking for a larger part of the whole. What 2013 made clear was that this process was going to move more quickly than some had anticipated, and that industry’s fears over its legal exposure on compliance questions might not allow them to push back against the Chinese government as forcefully as they once might have.
The third lesson is also the most basic: China is not going to be the panacea to MNC’s growth and earnings problems that was once believed. A handful of MNC pharmaceutical firms have already announced that their fourth quarter earnings would be lower than anticipated because of suppressed sales in China. Others have come out and noted that increased oversight of their domestic Chinese sales forces will lower sales for 2014 as well. According to Drew Armstrong, three of the largest MNC pharma companies – GSK, Merck Merck and Pfizer PFE +2.22% – have indicated their China growth will drop from its 2012 level of 40% to 20% in 2013. These are still impressive growth numbers, but they are well short of what executives, boards and investors were anticipating from China.
Worse still, the dynamics at work that should result in China becoming an attractive market – the emergence of China’s middle class, the chronic disease burden of the country’s rapidly aging workforce, and expectations for western-care – are all increasing the size of the market at the same time they drive intense pressure on government to lower costs. Pressure on prices within China could well be more severe and present itself sooner than MNCs had expected as the Chinese government focuses its energies on driving down the prices of pharmaceuticals and, in an equally unpleasant twist, domestic Chinese manufacturers prove adept at moving into target therapies that were seen as unique to MNCs.
China will remain an important life science market for years to come. But its overall impact on MNC revenue and profit may come up short of expectations. The political pressure on policy makers in Beijing to address inequities and high costs in the country’s healthcare system will inevitably bring additional public pressure on MNCs to lower prices. What MNCs have to trade for market access in China will become more of a strategic issue, and one that could easily embody larger unresolved geo-political questions that already strain the U.S.-China relationship.
In the end, the opportunities China creates for the global life science industry may simply delay the sector’s need to address core problems to its growth and profitability: how patent systems need to evolve to address drug discovery costs, more efficient mechanisms for drug discovery itself, creative public-private partnerships between the state and industry to address the next generation of public health crises, and how to better manage therapeutic costs with quality of life. That China may come up short of everyone’s expectations will be seen by some as a bad thing; that this realization may force a more aggressive pursuit of answers to these larger questions as a result, would be a net benefit to everyone.

Sources: Pharma and Heathcare