China’s pharmaceutical landscape has seen some significant changes recently. Growing discontent among the domestic public and rising pressure from the international community have ensured that the government’s recently released proposal to restructure the country’s health care system has much more substantial implications than just political posturing. Meanwhile, the newly opened Beijing and Shanghai offices of the U.S. FDA (Food and Drug Administration) in late November have signaled China’s increasing integration into the West’s pharmaceutical system.
Rachel Lee, partner and managing director in The Boston Consulting Group’s Shanghai Office, a 1998 Wharton graduate and a veteran in pharmaceutical industry, recently spoke with China Knowledge at Wharton about the growing presence of global pharmaceutical companies in China and what it takes to succeed in the country’s rapidly changing market.
Among her insights: Global pharmaceuticals are entering a new stage of development in China, and although the fast-growing industry is not on the frontline to be hit by the still-unfolding global financial crisis, multinationals have some unique challenges to overcome. She also offered her suggestions about how multinationals can survive in China’s post-reform pharmaceutical market.
Below is an edited version of the interview:
China Knowledge at Wharton: Let’s begin with an historical overview. What has been happening with global pharmaceutical companies in China over the last two decades?
Lee: Historically, over the past 15 or 20 years, we’ve seen multinationals entering into China, and if you look at top 20 global pharmaceutical companies today, almost every one of them has a presence here now. Multinationals brought both innovative products as well as general products to the China market, and they invested in factories and started manufacturing products locally…. That was in the late 1980s and early 1990s. There was also a wave echoing the government policy which encouraged multinationals to invest in China so the locals could learn more about technology.
China Knowledge at Wharton: Are multinational companies selling the same drugs in China as they do in the West?
Lee: Essentially, they have been selling the global portfolio [in China], but only in a selective manner. Typically, they choose older products for the China market; in other words, the latest, most innovative products will not be in China immediately — there is a time lag. But since the multinationals first entered into China, they enjoyed a preferential pricing treatment from the Chinese government. As long as you are the original inventor of the compound, you will be given a price premium.
China Knowledge at Wharton: Are multinationals doing well in China, compared with local players?
Lee: They have been doing fairly well because of the price premium offered by the government. They are selling good products, but some of them are essentially off patent globally. And with insurance coverage and self pay, they are mainly addressing patients who can afford those products in the top-tier cities. On the other hand, I think the locals are still very strong in terms of market share. Multinationals have about 30%, and the locals are about 70%.
But the multinationals have been growing tremendously in the recent years. The overall China market has been growing at 20% to 22% in the past five or so years, and the top ten multinationals have been growing slightly above that, between 22% to 25% in the last four or five years. That is very high compared with the global rate of 5%, which makes multinationals look at emerging market like China, India and Latin America as very hot spots.
China Knowledge at Wharton: What’s the latest trend for global pharmaceutical companies in China?
Lee: One recent trend in the last several years is [growing] investment in Research and Development activities (R&D).
Early in this decade, [multinationals] began to invest in R&D. For example, Roche in 2004 began to invest 10 billion dollars to establish its research center in Shanghai, and everyone else followed. So manufacturing was the [focus of the] previous decade, and this decade is [focused] on R&D. Basically, they are moving up the value chain.
China Knowledge at Wharton: What’s driving this new wave of investment in R&D?
Lee: One is the government policy; the most recent ten year plan lays out the strategic priorities, and innovation is one of them. On the other hand, multinationals also want to do this because by involving China in R&D, they can actually get fast market access.
China Knowledge at Wharton: How does China’s growth compare with other emerging markets?
Lee: China’s growth is the fastest, and it certainly offers a lot of opportunities for multinationals. The country is expected to become the fifth largest market with an estimated total size of about US$25-26 billion by 2010. Overall, the growth is very strong, although health care expenditure as a percentage of GDP is still fairly low — lingering between 4% and 5%. And the government does expect that to increase. As the country develops, health care standards and educational standards are going to improve. And we all know that the current health care reform is looking to improve that. So, we see a lot of growth potential for multinationals in China.
The market is very strong, you have a huge population of 1.3 billion people … [and] patients or consumers’ affordability is improving. These fundamentals are driving the growth of the China market.
China Knowledge at Wharton: So the fundamentals look very promising. What are the problems?
Lee: I think the China market is very challenging. It is quite complex from several dimensions. One is just in terms of a vast geography as well as the complicated regulation from central to provincial to local levels. So, for anybody to tackle all of China, it’s really a major undertaking. What the multinationals have been doing is they begin well in the wealthiest coastal cities in certain areas, and then they try to penetrate into a broader area. You need to deploy a very large sales force to cover all over China. It’s very costly in terms of reaching [consumers]. But in reality, the rural area, which [accounts for] more than half of the China market, is not available.
The other challenge is the regulations on several dimensions. One [dimension] is market access — basically it takes a long time to do clinical trials, to get registered, etc. If you take drugs already approved by FDA to Korea or some other countries, they only require a small bridging study, meaning that they accept the data from FDA and you just need to provide some additional data. But in China, you have to do this all over again if it’s a new product.
China Knowledge at Wharton: How long does it usually take?
Lee: Usually about three years: one year to apply for the clinical trials, another year to conduct the clinical trials, and then a third year to get the approval. So that’s one hurdle in terms of the speed.
The pricing policy is okay. As long as you are [a drug’s] originator, you receive good treatment. On the medicine reimbursement list, multinationals are on the B list, which means between 20% and 80% reimbursement ratios. Anything on the A list is basic – [consumers] get 100% reimbursement. So that poses an affordability issue for the multinationals; patients have to pay more to take foreign drugs.
China Knowledge at Wharton: Given the strong fundamentals, is every multinational company growing as fast as 25%?
Lee: Not all of them. Some of them are extremely high. Bayer and AstraZeneca, for example, are growing at 40%.
China Knowledge at Wharton: Why are some companies doing so well and other companies are not?
Lee: A good question. The ones that are doing really well are willing to invest in China. [There are] different kinds of investment. The most important is commercial investment. We just talked about the challenges of covering China’s vast geography, and reaching physicians there is very difficult. It takes money to do that. Bayer and AstraZeneca actually were the first ones to begin a very drastic sales expansion. They basically increased their sales force from 500 to 2500 today, five times in five years between 2002 to 2007. Sanofi invested similarly; I think right now they have about 1800 reps.
China Knowledge at Wharton: So, these investments really pay back.
Lee: Yes. To a large extent, that’s really the arms race to get into China, and to penetrate beyond. They may start with 30 cities, then 50, 100, and eventually cover 200 to 300 cities. To make the demand [for drugs] sufficient, you need to have a sales force telling doctors why they should prescribe the drugs — that’s very important for this business.
In addition, the top companies have also invested in different ways. Some of them focus on mergers and acquisitions. For example, Bayer acquired Topsun Science and Technology’s over-the-counter cough and cold medicine business two years ago. AstraZeneca is the most commercial, but they have been not only focused on the size of the sales force, but the effectiveness, the productivity of the sales force. They manage it quite well by doing a lot of sales force effectiveness improvement programs. They are getting things to a deeper and deeper level and improving the quality of the sales team.
China Knowledge at Wharton: How do the multinationals maintain ethical standards?
Lee: For multinationals, it’s very important they don’t breach ethical standards in this marketplace. That’s the fundamental difference between the multinationals and the locals. I think the global companies have been enforcing a lot of compliance rules on the local affiliates.
China Knowledge at Wharton: The FDA has recently set up offices in China. Why would they want to have offices here?
Lee: One of the assignments is to monitor the increasing R&D activity in China, especially with regard to clinical trials. There are opportunities and challenges. On the challenge side, there are quality issues and some IP concerns. When you do trials in China, for example, you need 2000 people; you recruit patients in China and Chinese doctors conduct the trials. Many Chinese doctors historically have not conducted large-scale trials and they are still learning how to do that — what are the right protocols, how to adhere to them, and how to treat patients in the right way. So there have been situations in the past, [such as] breaches of confidentiality, or not following the protocol. The FDA is increasingly receiving applications in which part of the data is coming from China, so people are getting worried. What if the data is not reliable? They want to be assured that the trial process is well conducted and the quality of the trial is monitored to meet [particular] standards.
I think it’s very positive for the industry. It puts more pressure on the principal investigator, on the hospitals, and on the companies who are sponsoring these trials to really adhere to these standards.
China Knowledge at Wharton: What has been the impact of the global financial crisis on pharmaceutical companies in China?
Lee: We have talked about this issue extensively within BCG and with our clients. The view is that there will be a time lag compared to other industries: Pharmaceuticals are not on the front line of being hit.
Rather, the industry is being impacted by its own problems regardless of the financial crisis. Globally, there is a lack of R&D — there is lack of new products coming up. The R&D challenge has been going on for the last five to ten years, and it is not going away.
China Knowledge at Wharton: Why has innovation slowed down over the last decade?
Lee: Oh, that’s a million dollar question. There are a couple of theories. One is that the lower hanging fruit has been picked. Beginning with the 1960s through the 1980s, that’s when the pharmaceutical companies flourished. I remember Merck was coming up with all kinds of new drugs in a very short period of time. For all the major diseases — like hypertensi