Doesn't the title seem familiar? It is a slogan we have used for many of our information products from the days of IMS China Update, a monthly newsletter well-known to many veterans of the Chinese pharmaceutical industry that we co-published with IMS in the 1990s. 

Today, we are faced with probably the toughest pharmaceutical market environment since the beginning of China’s reform in late 1970’s, and the recent asymmetrical heartbeats of the Chinese healthcare sector are blurring our vision for the future.  In this editorial, I will attempt to look into some recent pulses of the sector that may offer us a glimpse of future.

On the surface, April has been rather mild without the kind of violent turbulences we witnessed in the past few months.  However, things that are happening quietly must not be overlooked, as they may hide some subtle signs for the future.

I was not without surprise when the central government announced its approval in early April for the trial plan of the urban resident basic medical insurance program, before the future direction of the healthcare reform is decided.  From what I understood, the central government has been waiting for healthcare reform proposals from six different sources to finalize its healthcare reform plan. 

The Chinese government made clear that it wanted the new system to be financed primarily through participant premium contributions, which is in line with the existing financing mechanism of the urban employee basic medical insurance program, rather than government funding as many had hoped. In retrospect, when the government talked about its leadership role in healthcare, it may not have referred to funding, but rather to its leadership in regulating the sector, or leadership in public health and healthcare provision. It seemed that the government had already made up its mind about this financing model and thus there was no need to wait for a final resolution on the healthcare reform plan before initial actions such as trial plans could go ahead. 

The Chinese government said repeatedly that it would change the existing healthcare financing model under which medical institutions are funded primarily by revenues from drug sales. The Ministry of Health said this month that it will soon launch a number of new measures, in accordance with the new “Provisions for Drug Prescription, to ensure that medical institutions and physicians can not profit excessively from drug sales.  The ministry is also pushing for zero profit margins on drug sales by non-profit medical institutions. 

In addition, the Ministry intends to implement the emerging internet-bidding model for centralized hospital drug purchase nationwide in 2007 that aims to cut profit margins of drug products.  As a further step, MOH declared that it would strengthen regulation of post-tender drug purchase process to ensure clinical consumption of those low-profit margin drug products selected in tenders.

All of these measures will serve effectively to cut off the revenues of medical institutions from drug sales.  The question that remains to be answered continues to be: how will the medical institutions be funded?

The government may increase medical fees and possibly create a prescription fee system.  However, raising the medical fees too fast and too much will pose too much political risks and disturb social stability, so this is unlikely to happen.

The basic medical insurance programs are to become a major funding source, but maintaining the programs at low premiums will mean little or none profits for medical institutions.  The commercial health insurance sector is too small to play a meaningful role.  Will the government fill the revenue gap of medical institutions after they are cut off from their drug sales revenues?  The gap is estimated to be CNY tens of billions annually, and that is in addition to CNY 100+ billion working capital of the pharmaceutical industry that is being freely utilized by the medical institutions nationwide.

Reading all the signs we have so far, the government seems unwilling to foot this large bill. If the government does not pay, the medical institutions will eventually be forced to seek funding from patients through whatever means available to them.    Should this happen, the Chinese healthcare system will go back to the same loop it is in now. 

The percentage of total healthcare expenditures in Chinese GDP was around 5.5% in 2004. The rate has not changed much in the past ten years and it is comparable with that of Russia and lower than most Eastern European countries, not to mention developed nations.  Meanwhile, the out-of-pocket medical expenditures by Chinese urban residents rose nearly 10 times in the past decade, and the portion of healthcare expenditures funded by the government has fallen from 36% to only 17% in the same period.  With these facts in mind, it is easy to find that the outcry of the Chinese public over sharp increase of healthcare expenditures is not directed at the growth of overall healthcare expenditures, but at the sharp escalation of their self-paid healthcare expenditures. 

Improving efficiency and cutting profits of medical institutions and pharmaceutical companies alone will not be sufficient to change the overall picture. More government funding is crucial in making the ends of Chinese healthcare meet. The Chinese public have the right to demand some benefit from their tax money with better healthcare being one essential aspect. All those talks by Mandarins that “the present economic reality of China does not allow the government funding of universal healthcare” are cheap without putting the issue in perspective – how much tax does the government collect each year, and how much is spent on healthcare? Can some of the money currently spent on luxury official sedans and extravagant stately dinners be moved to the healthcare budget for its general public?

Hopefully the government will find a more balanced solution to it after all. 

The centralized hospital purchase tender system has been under constant fire by the pharmaceutical industry for its serious flaws. The internet-bidding model developed and experimented by Guangdong province improves on the former centralized hospital drug purchase tender system.  As the model gained support by many local governments, the Ministry of Health seized it as an opportunity to preserve the centralized hospital purchase tender system and to fend off criticisms. It is seeking to implement the model nationwide in 2007.

However, the model is still in its infancy and is going through many changes and fine tuning. The bright-side of the internet-bidding model is its better transparency, but critics say it focuses too much on price and fails to take into account other critical factors such as quality.  It is believed that additional provisions have been added to the model recently to ensure sufficient considerations for both better quality products and low-profit products under short supply.

Pharmaceutical companies also complain that such a model would cut into their profits too much, thus threatening long term sustainability.  A large number of pharmaceutical companies, including 40 MPCs, staged various protests during the recent internet bidding in Guangdong province. 

Core components of the new internet-bidding model experimented in Guangdong province include: 1) publication of maximum prices of drug products being tendered on the internet; 2) bid-submissions by suppliers and bid-screening by government experts; and 3) rounds of price negotiations over internet between government experts and suppliers.

In addition, the new model allows only one distributor between the pharmaceutical manufacturer and the medical institution, in an attempt to reduce profit margins in the distribution process. This requirement is quite hard to meet considering the reality of China’s fragmented pharmaceutical distribution system and strong local practice of protectionism. 

If the new model is implemented nationwide, which is likely to happen in 2007/2008, the profitability of the pharmaceutical industry will inevitably sink again.  Brand name companies also face the challenge of losing their market shares as the model focuses more on prices. 

While hospital drug purchase negotiators in Guangdong province got the thrills of their lifetime recently through axing prices of local drug products (sometimes slashing up to 90% of their original prices),  they were so agitated negotiating the prices of imported drugs that they turned to the local press to release their frustrations.  Consequently imported drugs received considerable negative publicity over their pricing in China with mounting calls for greater transparency for pricing of such products.

With prices of most local drug products beaten to the ground, the public and local elites are likely to pressure NDRC into seeking additional targets to reduce medical expenditures.  Imported drugs make an easy target!

It is unlikely that NDRC will simply order price cuts on such products, but rather it may demand greater transparency starting from requesting prices of imported drugs in their home and international markets, then maybe more information on their ex-manufacturer prices, and eventually leading to regulation of the import destination prices. 

The Guangdong provincial price control authority recently submitted to NDRC an experimental plan for regulating prices of all prescription drugs in the province.  What’s noteworthy is that the plan was developed with prior authorizations from NDRC.  Is it possible that this was initiated by NDRC? At this point, we can at least ascertain that NDRC welcomes this experiment. But will it be the direction NDRC is heading for?

Over 100 local pharmaceutical companies sent their second petition to the State Council recently after their first petition was basically ignored.  The second petition again harshly criticized many government policies including repeated price cuts and centralized hospital drug purchase tenders as being largely ineffective, prone for corruption, and suffocating the development of the Chinese pharmaceutical industry. The petition warns the government that failures of the local pharmaceutical industry will lead to a sharp rise in the consumption of expensive foreign drug products. While it blasted the existing centralized hospital drug purchase tendering system, the new petition suggested an option to establish a single national hospital drug purchase tender system. 

It is rare for Chinese companies to be so defiant openly to the government, and their bold act leads me to believe the local pharmaceutical companies are really desperate about their survival now.  However, in my opinion, the Chinese government has too much in its hands to worry about the survival of some local pharmaceutical companies.  After all, as long as the major state-owned pharmaceutical enterprises are preserved, the country should do fine with the supply of essential medicines. 

Many new market data and predictions became available to us in April, and let me tell you what I feel about these new figures.

While there are official statistics on the output and revenues of the Chinese pharmaceutical industry revenues and projections from various sources for the Chinese hospital, retail pharmacy and OTC markets, reliable estimates on the size of China’s overall drug market are hard to come by.

My take on the overall Chinese drug market (including finished Western medicines, biochemical drugs, formulated traditional Chinese medicines and herbal drugs) in 2006 is about US$42 billion at ex-manufacturer prices. 

My estimate is a rough figure developed on the basis of the official pharmaceutical
industry revenue figures (total pharma industry revenues from finished drug products   – ex-manufacturer export sales of finished drug products + imported finished drugs ).

Firstly IMS projected that the Chinese hospital market to be US$15.1 billion (at hospital purchase prices) in 2006 (an earlier quote from IMS HQ of US$13.4 billion might be the 2005 figure), with a slower growth of 12.3% compared with 20.5% in 2005. The company did not make any future predictions. 

The Chinese Pharmaceutical Association (CPA), which has a similar hospital purchase audit as IMS, reported that the Chinese hospital market grew only 9.2% compared with 20.3% in 2005.

Everyone agrees that the growth is slower in 2006 compared with previous years.  IMS’s 2006 growth estimate is much higher than that of CPA. It is possible that the growth rate estimated by IMS is based on US$ figures, while that by CPA is based on CNY.  The appreciation of CNY may have led to the discrepancy.

Southern Medicine Economic Institute (SMEI) reported that the Chinese retail pharmacy sales (among which drug products account for about 80%) rose 14.2% to CNY 90.1 billion (US$11.6 billion) in 2006, and this figure will climb 22.0% to CNY 110 billion (US$14.1 billion) in 2007.

SMEI did not specify why it is so optimistic about the growth of retail pharmacy sales in 2007. I am less buoyant about the sector’s growth prospect in 2007 because strengthened OTC regulations are likely to direct substantial retail drug purchases back to hospitals.  In addition, retail pharmacies may also lose some of their businesses to community healthcare facilities that are being heavily promoted by the government.

As this growth estimate was on the total sales of retail pharmacies, possibly SMEI is counting on high growth for health foods, devices or other products. 

Nicholas Hall & Co. projected China's OTC drug market to be at US$6.2 billion in 2006, up by 12.4% (comparable with that of 13.0% in 2005).  Nicholas Hall & Co. covers sales of officially-approved OTC drugs in all retail channels, and prescription sales of OTC-registered brands plus packaged herbal medicines (including branded TCMs). IMS also has a Chinese retail pharmacy audit, but we are unable to confirm if they have data specifically on OTC drugs. 

I believe the market for officially-approved OTC drug products will continue to grow steadily in 2007 and in the next few years.  With the recent introduction of a new set of drug advertising regulations, the Chinese OTC drug market seems to be relatively free from major turbulences or growth barriers ahead.  Strengthened control on drug advertising will create a cleaner and more orderly market environment that is good for long term and healthy development of the sector.

Both Novartis and AstraZeneca reported slower growth in 2006. It seems Novartis was hit hard with only 6% growth, while AstraZeneca in fact fared quite well with 19% increase. Both companies remained upbeat predicting at least 20% growth for 2007 and the next few years.

Tianjin SKF, however, was reported to have suffered from a 40% drop in its profitability in 2006, largely due to senior personnel instability last year. However, the company denied later that the fall was caused by personnel changes.

2006 results for major local pharmaceutical companies appear quite varied. Some companies reported higher earnings while others saw their profits dip dramatically.  Zhuhai Lizvon recorded a 29% rise in net profits on lower sales, while its controlling shareholder, Joincare Group, announced a plunge of 161% in net profits.  In general, more local companies skidded into losses and together their total losses jumped 26% in 2006, according to official statistics.