On April 6, the Chinese government published the details of its long-awaited health care reform plan: It will spend RMB 850 billion (US$124 billion) over the next three years to extend health care deep into the provinces and rural areas, by upgrading and expanding the country’s basic medical infrastructure. Inside the big cities, it will try to relieve pressure on the hospitals by establishing a network of community health centers. For rural areas, the goal is to strengthen township hospitals and rural clinics. The government is also finalizing a National Essential Drug List (NEDL), a list of low-cost generic drugs that will be completely covered by insurance and will be reimbursed by the government.
The sweeping reforms, which will eventually provide health insurance for everyone in the country, contain good news and bad news for multinational drug companies. On the plus side, the consumer pie will grow, and firms will continue to sell high-end drugs in city hospitals; on the other hand, the plan will emphasize high-volume, low-value-added generic drugs that will be sold via the National Essential Drug List scheme.
Under the current system, hospitals earn most of their profit by pushing high-end drugs, a system that has benefited the multinational drug companies, which have largely concentrated on selling innovative, expensive pharmaceuticals through big urban hospitals. Under the new system, which de-emphasizes those hospitals in favor of an expanded medical infrastructure, the multinational drug companies will need to concentrate on rural areas and low-margin drugs if they wish to grow beyond their current niche of selling high-end drugs through hospitals. This amounts to a serious challenge because in China, even the generic drugs made by multinationals are often more expensive than those made by their local competitors.
To succeed in the new environment, international drug companies will likely have to change their strategies, and follow the money to rural and community health centers, according to industry experts.
The Basics of Health Reform
With the new plan, Beijing is trying to reduce out-of-pocket health care expenses for its citizens, which have been rising for the past 30 years — an aim that has generated praise. “The broad principles contained in the Chinese government’s new health care reforms are in line with what the World Health Organization (WHO) is promoting,” noted WHO head Margaret Chan. “For example, the principle of having the poor [covered by] health policies.”
Li Ling, a key advisor to the health reform plan from the China Center for Economic Research at Peking University, was similarly positive. “The health reform plan is creative and commendable,” Li told the media. “The plan has taken a step toward universal access to basic health care services for all Chinese citizens.”
The essence of the plan is its attempt to establish universal access to the already-existing Basic Health Care System by establishing a network of basic medical infrastructure in both rural and urban areas; to provide health insurance for all citizens; and to reduce the cost of medications by launching the National Essential Drug List. “The Basic Health Care System is a mechanism that helps to address the unmet need of basic health care services among the public,” Hu Shanlian, vice director of China Health Economics Institute of Ministry of Health, said during a press conference. “As a core part of the Basic Health Care System, the government will soon release a National Essential Drug List that covers the medicines most used in clinics, and all these drugs will be reimbursed.” To ensure that those essential drugs are affordable and of high quality, the health reform plan has stipulated a set of policies governing procurement, distribution and prescriptions.
The central government will set price caps for all essential drugs, and then each provincial health authority will organize a transparent bidding process for procurement within the province. The provincial health authority will fix the final purchase price of those drugs, but it will be lower than the cap set by government. According to the health reform plan, all of the Basic Health Care facilities should use drugs from the National Essential Drug List, while other medical institutions should make NEDL drugs their first choice for all prescriptions.
The reforms will also increase public medical insurance coverage, which will reduce out-of-pocket medical expenses for citizens. And by improving the basic health care infrastructure, the government hopes to enhance the quality of front-line health care service providers, and encourage patients make the rural clinics, township hospitals and urban community health centers their first choice when they get sick, says Hu.
Basic Medical Infrastructure
“The government is providing more insurance coverage to more of the population, so affordability is going to improve,” says Rachel Lee, partner and managing director of The Boston Consulting Group’s Shanghai office. “Second, they realize there are structural issues with the current service provider [hospital] system. As you know, 70% to 80% of the hospitals in China are state-owned and some of them are very inefficient, and there is insufficient government funding for hospitals, so hospitals actually rely on selling drugs.”
The government “is trying to establish a primary care system using the current class-one hospitals and some of the class-two hospitals, which will be converted into so-called community health centers,” Lee notes. “It essentially is going to channel a lot of the patient volume into the community health centers. If you have minor diseases or need to refill drugs, you can just go to a CHC.”
Of the US$124 billion total investment in health reform over the next three years, two-thirds will go to health care service users (public medical insurance) and one-third will go to health care service providers (medical institutions), said Wang Jun, vice minister of China’s Ministry of Finance, at a press conference.
That will create an immense market opportunity in the rural and community health centers, says Niu Zhengqian, vice general manager of China’s largest privately owned pharmaceutical distribution company, the Jointown Group. The group has already enjoyed success by targeting Rural and Community Health Centers, a niche that has traditionally been neglected by big distributors. Jointown is now China’s third-largest pharmaceutical distributor, with annual revenues of RMB 18.8 billion (US$2.8 billion) in 2008. “Based on the government’s detailed health reform plan, a great majority of the investment will go to the rural and community health centers,” Niu notes. “They will become a market too big to be ignored.”
A Changing Market for Multinationals
According to Wang Youhong, a health care industry analyst at Hai Tong Securities, the recently launched reforms will change the way the multinationals do business in China. Previously, pharmaceutical companies targeted large urban hospitals, as those hospitals made much of their profit by selling innovative, high-end drugs. That market will continue to grow, but a new engine of sales growth in China will be in the government-funded rural clinics, township hospitals and community health centers.
Under the old system, the local pharmaceutical players, which mostly sold generic products, profited by selling drugs at low prices through aggressive sales incentives, while multinational players profited by selling their high-margin drugs through hospitals. Now the rules have changed, and all pharmaceutical companies, both local and international, will have to work out new strategies to take advantage of the changing market, says Wang.
Companies with products on the National Essential Drug List, which is expected to be published by the end of this month, will have direct access to the market, but they will need suitable drugs and extremely efficient manufacturing processes if they wish to profit. Given the strict caps on drug prices, and the provincial bidding process, the profit margin on NEDL-approved drugs is likely to be seriously squeezed. This market sector might prove difficult for multinational pharmaceutical companies, whose products are mostly high-end patented drugs, and who often have constrained production capacities in China. If they don’t have suitable products in their current portfolios, they may need to consider expanding their production capacities, or acquiring local players that have suitable products, according to a health care analyst.
Pricing is another serious issue: Drugs on the NEDL list will be sold both through the Basic Health Care System and to hospitals outside the system. However, if the low prices used in the Basic Health Care System are also adopted in high-end hospitals, profit margins will be sharply reduced. Apart from that, companies will also have to deploy a unique sales model that addresses the requirements of the Basic Health Care System channels, according to the analyst.
At stake is an enormous pharmaceuticals market. “The overall China market has been growing over 20% in the past five years, and the top ten multinationals in China have been growing slightly above that, between 22% to 25% in the last four or five years,” says Lee of BCG. “That is very high compared with the global rate of 5%, which makes China a very hot spot for global companies. The country is expected to become the fifth-largest market with an estimated total size of about US$25 billion to US$26 billion by 2010.”
A Successful Blueprint
Bayer Schering Pharma China is one multinational pharmaceutical company that has taken meaningful steps to expand beyond big city hospitals and penetrate the rural and community areas. It has done this by involving itself in seminars, conferences and events associated with the Basic Health Care System. For example, in October 2007, Bayer Schering Pharma and China’s Ministry of Health jointly launched a “Go West” rural physician training program, aimed at enhancing their overall capabilities in primary care and pediatrics.
The program, which began in Lanzhou, involves training more than 10,000 physicians in 332 rural counties in 11 of China’s less developed provinces. And in June 2008, Bayer Schering Pharma announced that it would provide RMB 10 million (US$1.5 million) in sponsorship to help the Ministry of Health’s Community Health Service Promotion Program, which aims to enhance public awareness of community health services. Bayer Schering Pharma has also sponsored other similar large-scale seminars, many of them related to the Basic Health Care System.
Bayer Schering Pharma’s aggressive investment and long-time efforts in these not-for-profit events is not surprising, analysts note, and it has enjoyed a remarkable payback. It is now among the leading multinational drug companies in distributing pharmaceuticals through grassroots medical institutions.
Glucobay, Bayer Schering Pharma’s first-line treatment for type II diabetes, has enjoyed a compound annual growth rate of more than 30% over the last ten years. Sales of this product in 2008 in China alone reached RMB 1.16 billion (US$169.54 million), accounting for one-fourth of the company’s total revenue.
Bayer Schering Pharma’s 2008 acquisition of the over-the-counter (OTC) cough and cold medicine business of Topsun Technology, one of China’s leading OTC companies, was also in accordance with its rural and CHC market strategy. A recent market survey showed that more than 60% of the OTC sales in the recent years of Xian Janssen, China’s most successful OTC player, were derived from rural and community health centers. That may explain why Bayer Schering Pharma spent so much money (almost 120 million euros) acquiring a generic OTC company in China.
Like Bayer, other pharmaceutical companies have been working on strategies to cope with the new opportunities and challenges emerging from the Basic Health Care System.
Local Drug Companies Brace Themselves
The health care reform will likely mean a massive shakeout for local drug companies and distributors, says Lee. “Drugs on the NEDL list will be essentially purchased by the government and the price will be very low, and they will designate only a few players to play,” she says. “So, out of all those 4,000 local drug companies, if they all want to [be part of the NEDL], the competition will get extremely intense and few will survive. And the products are going to be sent directly from the manufacturers to the hospitals, so that will hurt the distributors and the smaller players who are not that strong.”
Local companies face two choices, says Lee. One is to concentrate on large economies of scale, and a low-cost structure, so they can compete on price. The other is to try to compete in the high-end market against the multinationals, but to do that, they will need to be innovative in a fiercely competitive industry. “It’s going to be very difficult,” she says.
Not everyone believes that China’s ambitious health care reform will be successful. Song Ke Ying, an experienced surgeon at a major Shanghai hospital, is almost sure that it will not work. Dr. Song, who has two postdoctoral medical degrees from China and the United States, says the reform lacks incentives to motivate doctors, who already receive much lower compensation than doctors in the West. Consequently, he says, the effort to reduce drug sales in hospitals is not likely to have the desired effect.
As for the RMB 850 billion total investment, Dr. Song believes China is so vast, with so many hospitals, that any single community health center will receive relatively little benefit. He believes that the reform should address the low pay received by doctors, a topic that is not mentioned in the government’s plans.
In any case, in a country as large as China, and with an industry as entrenched and enormous as health care, progress will be incremental no matter what. “We call this an evolution, not a revolution,” says Lee. “China’s health care system is complex, and you can’t expect any reform to change things overnight.”