China's Healthcare Reforms: Double-Edged Sword For The Pharmaceutical Industry

By Michael Custer, Consultant, Solidiance

China’s healthcare system has served the rapidly developing country well. China impressively succeeded in its efforts to achieve universal healthcare coverage, bringing the insured rate up from 50% in 2005 to 95% by 2011. And, despite achieving universal coverage – a rarity for developing countries – the country has been able to keep costs relatively in check, spending just 5.5% of GDP on healthcare in 2014.

While the healthcare market may see potential future growth, two trends are threatening the long-term sustainability of China’s system. Firstly, China is experiencing a rapidly aging population. China’s old age dependency ratio, a reliable predictor of healthcare costs, will match that of modern day Japan by 2045.

Old age dependency ratios for selected countries and country groups (%)

Sources: United Nations Population Division, WHO, Solidiance research and analysis

1 - Old age dependency ratio = total number of people over 65 years old )/ (working age population- total people from 15-64 years old)
2 - Average of middle income countries and average of high income countries as defined by the United Nations

Secondly, more of its population is increasingly becoming unhealthy. The rates of many chronic diseases as well as cancer are on the rise in China due to pollution, poor diet and unhealthy lifestyle choices. To put this in perspective, the diabetes rate in China is already higher than that of the United States.

Without enacting any reforms to the current system, these trends will lead to enormous strains on the government’s budget. According to Solidiance’s white paper titled “China Healthcare Reforms: Who Will Survive?”, it is projected that 20% of China’s government budget will be allocated to healthcare by 2045. That figure is nearly double what it is today, and behind only New Zealand and the United States.

Under more realistic scenarios, considering China’s growing health problems and an increased share in healthcare funded by the government, the share of state budget allocated towards healthcare will range from 24% to 33% - figures that are by far the largest in the world.

Four scenarios of China’s healthcare market in 2045, as a result of government expenditure spent on the sector (%)

Sources: Solidiance research and analysis

Without change, China’s current healthcare system will become unaffordable. The latest round of reforms, launched towards the end of 2015, are thus aimed at ensuring sustainability by reducing costs so as to create a more efficient healthcare system to its people. The reforms, if implemented effectively, will have a significant impact on companies operating in the sub-sectors of Medical Devices, Pharmaceuticals and Healthcare Services.

Specific Reforms impacting pharmaceutical companies in China

The pharmaceutical industry in China is massive. By some estimates, it takes up around 40% of all healthcare expenditure, a proportion that is much larger than other countries. Due to the industry’s size, pharmaceutical companies are likely to feel the brunt of the government’s cost cutting reforms. 

The two main methods by which the government is exerting downward price pressure on pharmaceutical companies is through directly pressuring companies to reduce their bidding prices. This is done through the introduction of the two-fapiao[1] invoicing system.

The government has significant influence over pharmaceutical prices through the bidding system – the process by which drugs are approved by provinces for use in hospitals. Every new round of bidding leads to further price reduction. This pressure to reduce prices, sometimes by as much as 30%, is being exerted on both local companies and foreign competitors. However, it is the foreign MNCs who will feel the most pain, as it is often much easier for the domestic competitors to find further cost reductions and accept lower margins for their products.

Specific healthcare reforms impacting the pharmaceutical industry in China

The two-fapiao invoicing consists of cutting out tier 2 and tier 3 distributors and thus reducing the mark up on drugs for hospitals and healthcare facilities. The policy states that from pharmaceutical manufacturer to hospital there must only be two transactions (fapiaos) – 1) manufacturer sells to distributor and 2) distributor sells to hospital/healthcare facility.

Potential impact brought about by the reform on pharma channels in China

The introduction of longer clinical trials is typically viewed positively by multinational companies as it represents a move towards more standardization of the drug approval process. This reform, combined with the requirement for generic drugs to go through the ICC (industry Control Correspondence Report) approval process, will lead to consolidation among domestic companies as smaller competitors that compete solely on price will be forced out of the industry. And, the move to a Disease Group Reimbursement system, which has the goal of cutting costs for in-patient hospital treatments, will force healthcare service providers to be more cost conscious in selecting pharmaceuticals.

Opportunities for pharmaceutical companies in China

Despite the reforms adding additional complexity, it is important to remember that China’s healthcare market is large and growing rapidly, with value projected to surpass 1 trillion USD by 2020. With a market of that size, there will remain strategies that multinational pharmaceutical companies can pursue to ensure a piece of the pie and capitalize on opportunities in China.

Innovative, unique and needed drug products that have few or no domestic replacements will continue to be in high demand in China and demand a price premium. Thus, companies should continue to emphasize R&D and the development of new drugs. Additionally, China will remain a large and fast growing healthcare market with many profitable niches. Drug companies should seek out the geographic markets and market segments that are favorable to them and focus on niche products with profitable margins.

About the Author:

Michael Custer is a Consultant at Solidiance based in Shanghai, China

About Solidiance

Solidiance is a corporate strategy consulting firm with focus on Asia, from Dubai to Shanghai. We advise CEOs on make-or-break deals, define new business models and accelerate Asia growth. Through our 12 offices across Asia, we provide our clients with a better understanding of intrinsic regional issues and develop strategic growth plans.

http://www.solidiance.com