Downward pressure on drug costs intensifies risks for Big Pharma in China
March 2011 was an exciting period for China as the country adopted its 12th five-year plan and embarked on its latest reform expedition. Amidst the rhetoric of strategic restructuring and opening of its economy, there was also an explicit target to fix the healthcare system which has clearly lagged in comparison to gains in other sectors. According to the UN, the over 60 population in China amounted to 178 million people in 2009. Increased urbanization and the one-child policy have decimated the tradition of family care, with the burden now being shifted onto the state. Additionally, not counting rural shortcomings, an estimated 800 million do not have access to hospitals in major cities. Understandably then, the latest reform measures are geared towards meeting the countries massive healthcare demand, including - the expansion of basic health insurance, capacity building in terms of physical infrastructure and human resources, and the inevitable cost cutting. While greater penetration and acceptability of modern medicine by this generally traditional medicine oriented society could be a windfall for foreign pharmaceutical companies, simply covering the basic health needs of the population by the centralized schemes will be incredibly expensive. With the pharmaceutical market growing at around 25% p.a, and sales projected at $125 billion by 2015, industry understands only too well that the Chinese opportunity is a double edged sword.
The challenge then, from the payers’ perspective, is to increase access while controlling costs. Consequently, for manufacturers, the opportunity cost now involves balancing lower margins with larger volumes. It is this margin versus volume trade-off that the government wishes to exploit in order to control drug costs- evidenced by the increasing popularity of the Anhui model of reimbursement. Over the past two years, the rural province of Anhui has made waves in the political sphere due to their success in controlling drug costs. They have done so primarily by legislating a 0% mark-up for drugs on the Essential Drug List (EDL), and by implementing a centralized bid/tender process. This has completely disrupted the national policy of allowing doctors and hospitals to mark-up prescription drugs, as a method of generating revenue and operating profits. It is evident how such an arrangement could conflict with cost-control efforts. Hence, 18 of China’s 23 provinces have now adopted all, or part of the Anhui model. Furthermore, the promotion of policy pioneer Sun Zhigang, from vice-governor of Anhui province to director of the Office of Health Reform, signifies the central governments’ approval of such fiscally prudent policies.
Anhui’s approach to controlling costs could have adverse implications on several fronts across the entire supply chain. Firstly, its fixation with pursuing the lowest possible price overlooks the relationship between price, quality and effectiveness. Although the bidding system does involve a review of each manufacturer’s technical capacity and quality controls, justification behind the winning bid ultimately filters down to who can supply at the lowest price. The incentive to compete solely on price could come at the cost of decreasing quality standards. With lower price margins, the temptation to maximize returns by cutting corners on quality is immense. Secondly, the 0% mark-up has, in some cases, resulted in products not being locally stocked. Distributors and clinics can’t afford to carry these products as they cannot make any money on them, and doctors hesitate to prescribe them as they cannot make money nor can they trust their quality. Thirdly, the possible expansion of drugs on the EDL or the drifting of such a policy to cover other classes of premium priced products, could limit access to product portfolios of both local and multinational firms alike. More importantly, the Anhui model demonstrates the disconnect between achieving short term financial sustainability and long term national objectives such as public hospital reform , retention of trained professionals, and improvement of quality standards. While individual provinces could be better placed, eliminating a key revenue stream may prove to additionally burden the central government who will struggle to adequately fund and incentivize doctors and hospitals, hence weakening the very foundations of its reform targets.
Like many strategic sectors targeted by a state-driven reform process, China’s domestic pharmaceutical industry simply does not have the process capability to be self sufficient without the presence and participation of the established multinationals. A hard-line approach that strains relationships with big pharma could be disastrous to the sustainability of any reform policies. In the future, a more flexible and balanced plan is essential in order to restore confidence in foreign players who cannot compete on price against generics, and are wary of China’s poor track record on enforcing intellectual property rights. The Anhui model certainly has its merits in terms of lowering costs, increased purchasing efficiency and securing supply for an expanding list of essential drugs. However, in its current form, its implementation fails to recognize some of the wider downstream effects it could impact on. As is often the case in healthcare, a myopic focus on the bottom-line could threaten greater reform objectives as well as tarnish China’s attractive proposition for foreign investment.
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The challenge then, from the payers’ perspective, is to increase access while controlling costs. Consequently, for manufacturers, the opportunity cost now involves balancing lower margins with larger volumes. It is this margin versus volume trade-off that the government wishes to exploit in order to control drug costs- evidenced by the increasing popularity of the Anhui model of reimbursement. Over the past two years, the rural province of Anhui has made waves in the political sphere due to their success in controlling drug costs. They have done so primarily by legislating a 0% mark-up for drugs on the Essential Drug List (EDL), and by implementing a centralized bid/tender process. This has completely disrupted the national policy of allowing doctors and hospitals to mark-up prescription drugs, as a method of generating revenue and operating profits. It is evident how such an arrangement could conflict with cost-control efforts. Hence, 18 of China’s 23 provinces have now adopted all, or part of the Anhui model. Furthermore, the promotion of policy pioneer Sun Zhigang, from vice-governor of Anhui province to director of the Office of Health Reform, signifies the central governments’ approval of such fiscally prudent policies.
Anhui’s approach to controlling costs could have adverse implications on several fronts across the entire supply chain. Firstly, its fixation with pursuing the lowest possible price overlooks the relationship between price, quality and effectiveness. Although the bidding system does involve a review of each manufacturer’s technical capacity and quality controls, justification behind the winning bid ultimately filters down to who can supply at the lowest price. The incentive to compete solely on price could come at the cost of decreasing quality standards. With lower price margins, the temptation to maximize returns by cutting corners on quality is immense. Secondly, the 0% mark-up has, in some cases, resulted in products not being locally stocked. Distributors and clinics can’t afford to carry these products as they cannot make any money on them, and doctors hesitate to prescribe them as they cannot make money nor can they trust their quality. Thirdly, the possible expansion of drugs on the EDL or the drifting of such a policy to cover other classes of premium priced products, could limit access to product portfolios of both local and multinational firms alike. More importantly, the Anhui model demonstrates the disconnect between achieving short term financial sustainability and long term national objectives such as public hospital reform , retention of trained professionals, and improvement of quality standards. While individual provinces could be better placed, eliminating a key revenue stream may prove to additionally burden the central government who will struggle to adequately fund and incentivize doctors and hospitals, hence weakening the very foundations of its reform targets.
Like many strategic sectors targeted by a state-driven reform process, China’s domestic pharmaceutical industry simply does not have the process capability to be self sufficient without the presence and participation of the established multinationals. A hard-line approach that strains relationships with big pharma could be disastrous to the sustainability of any reform policies. In the future, a more flexible and balanced plan is essential in order to restore confidence in foreign players who cannot compete on price against generics, and are wary of China’s poor track record on enforcing intellectual property rights. The Anhui model certainly has its merits in terms of lowering costs, increased purchasing efficiency and securing supply for an expanding list of essential drugs. However, in its current form, its implementation fails to recognize some of the wider downstream effects it could impact on. As is often the case in healthcare, a myopic focus on the bottom-line could threaten greater reform objectives as well as tarnish China’s attractive proposition for foreign investment.
