China: Business as UNusual - Pharmaceutical Executive

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China: Business as UNusual
If there is one market this year that requires a click on the refresh button, it's China. If the 'growth curve' key was pressed, it should be your first delete. Pharm Exec's local partner, General Biologic, logs on with a snapshot of what's ahead for Big Pharma in managing for long-term success


Pharmaceutical Executive


How will MNC Pharma Respond?

The route to future success for multinational pharmaceutical companies in China may in fact be a forked one, with innovative/patented products on one side and consumer health product lines on the other. The middle path of branded generics, today a mainstay of many pharmas, will see comparatively less activity. Sanofi-Aventis's recent $520 million acquisition of BMP Sunstone, the largest cross-border consumer health M&A play in China to date, may be a blueprint for things to come.

With branded generics in danger of becoming commodity products, pharmaceutical manufacturers will need to look to their diversification strengths in forging a path forward. Sanofi, which has a major global consumer health presence, has added nationally recognized pediatric and women's health brands to its China portfolio and acquired a large sales network with the Sunstone transaction. While generic pharmaceuticals become a low-price/high-volume, government supplier game—one that only major Chinese domestic pharmas will win—the OTC and consumer health area will remain comparatively untouched, and perhaps even further invigorated, by the reforms. Pushing patients to self-funded OTC products sold at retail pharmacies instead of reimbursed/subsidized ethical drugs is one method of relieving the strain on government coffers in paying for the broader goal of universal health coverage.

For many of the reasons listed above, implementation of the new reforms will fuel consolidation in the domestic pharmaceutical industry. Many companies that have survived on aggressive physician incentives and local relationships and protectionism may be confronted with a less-hospitable business environment. Overseas drug manufacturers may encounter increasing numbers of potential M&A targets as well as larger, better-organized competition among the remaining domestic champions.

Getting the Balance Right

China's retail pharmacies are currently suffering a double identity crisis, at once both externally unsure of their place within the healthcare system and value chain, and internally struggling to find sustainable business models and successful product mixes. China Nepstar Chain Drugstore, the nation's largest retail chain pharmacy by sales revenue (and an industry bellwether), reported 2010 second-quarter revenues of RMB 565 million (US$83 million), an increase of 5.8 percent over the same period in 2009. This is a comparatively lackluster showing in a pharmaceutical market that has seen growth rates upwards of 20 percent. Like pharmaceutical manufacturers, pharmacy chains will also need to evolve and adapt to the changing face of China healthcare.

Drugstores are under pressure on several fronts. The pricing reductions being applied to prescription pharmaceuticals hits pharmacies as well as manufacturers, and it is likely that ethical products will continue to represent a decreasing portion of drugstore sales. Moreover, zero markup policies for medicines on the essential drug list mean that these will be loss leaders, or, more likely, simply pulled from pharmacy shelves. Also, even though hospitals have been told that drug profits are to be minimized in the future, they continue to steer patients to in-house pharmacies. In particular, the growing phenomenon of e-scrips, whereby physicians transmit prescriptions straight to hospital pharmacies at the end of a consultation and patients need only present their ID/insurance card, seems almost expressly designed to make sure patients do not stray beyond hospital walls to purchase medications.

Despite these pressures, retail pharmacies may have some key advantages moving forward. As mentioned above, governmental desires to offload drug costs to medical consumers, as well as reduced incentives for physicians to prescribe ethical drugs (if not needed), will likely increase OTC usage. Also important will be consumers' desire for choice. As the essential drug policy rolls out, there have been instances where Chinese medical consumers have demonstrated that they will shun facilities offering reduced formularies. Retail pharmacies will presumably be able to benefit from such activities if they are able to offer higher-end products that local hospitals cannot. Finally, the government itself may call upon drugstores to serve as surrogate in-house pharmacies for clinics. Early reports indicate that the "Development Plan of China's Medical Distribution Industry (2011 to 2015)," a policy currently in the drafting stages, suggests that community medical institutions need not establish their own in-house pharmacies if there are retail pharmacies nearby.

China's retail pharmacies are already responding to the shifting landscape with concerted efforts at diversification. Drugstores will tinker with product mixes and move away from ethical products to include nutraceuticals, personal care items and devices, household consumables, and convenience merchandise. Some smaller chains have already chosen to focus on more high-end/high-margin products, while larger operations will likely increasingly extend their footprint into the market space occupied by convenience stores. Promotions inspiring customer loyalty as well as reward card/points programs will also be on the rise.

Consolidation is Next

Like the domestic pharma industry, M&A activity is on the horizon too. To be sure, the retail pharmacy sector has already undergone several rounds of consolidation; however a recent uptick in M&A activity in the sector suggests that there is more to come. There are now a number of strong players in the retail pharma space, yet it remains the case that China still lacks a truly nationwide drugstore chain. But perhaps not for long: Much of the recent deal flow in the retail pharmacy space can be considered land-grabs by large retail pharmacy chains and/or large pharmaceutical distributors.

Retail drugstores are also being purchased by large conglomerates, with interests in other areas of the pharmaceutical commerce value chain, in particular by distributors such as Sinopharm and Shanghai Pharmaceutical. While conglomerate/SOE ownership of pharmacy chains is not new, it is likely that, rather than being isolated assets in a sea of healthcare holdings, attempts will be made to better synchronize gearing between distribution and retail assets (especially with central procurement now sucking profitability out of distribution in many cases).

China's drugstores will be profoundly affected by the rollout of China's new healthcare system, but, viewed as more commercial rather than medical-related businesses, they arguably have one of the weakest voices in determining the direction of medical reform. (The other laggard is China's beleaguered physicians.) The retail drug industry will need to be nimble in its navigation of the path forward. It must take pains to remain part of China's new health system to prevent being bypassed in delivering products to medical consumers, but at the same time avoiding, as much as possible, shouldering the burden for subsidizing the system.


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