China 2020: Walled In No More - Pharmaceutical Executive


China 2020: Walled In No More

Pharmaceutical Executive

Pharma Reform: Gains and Losses

The short term will see significant changes in the way medicines are marketed, priced, and reimbursed. Like any structural change, there will be winners and losers—including foreign drug makers that fail to adjust their portfolio product mix to appeal to a range of new constituencies, from the rural poor to urban hospitals seeking new sources of funding, or to a vastly more consolidated distributor base.

A basic misalignment of incentives at China's public hospitals and other healthcare institutions has traditionally driven the preference—and overuse—of higher-priced proprietary foreign medicines rather than the generic drugs produced by domestic firms. In China, major government-owned hospitals nationwide are granted administrative monopoly power in pharmaceutical dispensing, accounting for about 75 percent of total drug retail sales and 60 percent to 80 percent of a hospital's annual revenue. Overall spending on pharmaceuticals accounts for about 43 percent of total healthcare expenditures, or 1.9 percent of GDP in China, compared to only 10 percent of healthcare spending on drugs in the US. The top 100 drugs account for a little over half of Chinese hospitals' drug retail sales.

Profit from a hospital's drug sales is routinely used to subsidize much of its medical services, pricing for which has been kept artificially low due to the low value placed on professional services. As a result, patients are often subject to unnecessary drugs and treatment. This perhaps explains Chinese patients' common mistrust of physicians and other medical professionals. The macroeconomic consequence of the mismatch between need and costs is that hospitals are incentivized to buy and dispense (by contracting in-house physicians) higher-priced imported drugs at larger quantities to patients because they make more profit this way. In turn, these profits are deployed to help defray the cost of medical care overall.

China's ambitious healthcare reform blueprint aims to change this misalignment. But the central government has met with severe resistance as the new policy only tries to eliminate the price differential between wholesale and retail. Under the reform, hospitals will no longer be allowed to add the price premiums to drugs at retail and there will be no replacement offered for this lost revenue stream that would compensate the hospitals in subsidizing care for the many new patients entering the healthcare system. The fundamental question is: How will hospitals maintain a reasonable revenue stream when government payments for core medical services remain artificially low?

One possible approach to plug the gap is to restructure the professional service fees and incentive mechanism of doctors and medical institutions by using a different provider payment system under public medical insurance, including adopting a capitation model in outpatient reimbursement covering one price for a package of services linked to a diagnosis. However, this will likely be a long and challenging process that requires consensus among all the stakeholders, including medical professionals, patients, administrators, and policymakers. Despite its authoritarian framework, China is essentially no different than other countries on the subject of health; interest group dynamics are still writ large, and foreign drug makers would be wise to devote adequate resources to influencing these stakeholders as a way to structure the reform debate.

It is inevitable as well that the government will seek to wrest more savings from the drugs bill, chiefly by reviewing the special price protections on innovative foreign medicines introduced before China became compliant with global standards of intellectual property (IP) protection. In effect, this makes the lower-priced categorizations of medicines placed on the public Essential Drugs List the benchmark for future pricing in China, regardless of whether the manufacturer deems it innovative or not. The logic is clear: In the years ahead, price and clinical value differentiation is going to become as important to patient access in China as in any other global market.

From 'Made in China' to 'Innovated in China'

Health reform has been coupled with an equally ambitious industrial strategy for the biopharm sector. In 2005, the Chinese government outlined a "Medium to Long-term Plan for National Science and Technology Development" geared to achieving status as an "innovation-driven" country by 2020. This was followed by 76 specific policies introduced at the end of 2008.

Without homegrown, high-caliber science and technology talent—many Chinese scientists have spent years overseas to obtain education, industry connections, experience, and know-how—China will not be able to realize its innovation policy. The government has responded by generating a variety of new incentives to persuade this China-born overseas talent to return and lead new discovery and development initiatives. The incentives include high salary adjustments, funding and resources, subsidized housing, tax breaks, and benefits sharing. Most importantly, the most talented returnees are given key positions with significant responsibilities and organizational impact that would not have been possible in their adopted countries.

Coupled with the lackluster economy and depressed job market in the big pharma centers of the US and Europe, this policy has been quite effective. Overall, about 80,000 Western-trained Chinese scientists have returned to the country to work in academia or industry during the past decade. A large number of the returnees are from the life science industry, due to the high percentage of graduate and post-doctoral researchers admitted to Western universities and research institutions in biomedical research fields.

Of course, there is some danger in this scenario for the Western-based Big Pharmas, particularly over the long-term. That is, will the emphasis on promoting technology transfers to Chinese companies result in an effective cannibalization of Big Pharma's key skill sets, leading to the creation of a China-based, globally competitive biosciences sector with the scale and reach to dominate the domestic market but also to seize the competitive advantage in multiple markets beyond China itself?


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