SHANGHAI – China's growth story is changing. For almost a decade, 15 percent growth rates year over year for the pharma sector were the norm. But in 2015, multinational corporations struggled to hit growth rates in the upper single digits and that moderate growth is expected to continue in 2016, according to BMI Research.
A close look at 2015 year-end financial disclosures illustrates that point. Eli Lilly and Co. reported 2 percent year-over-year sales growth, with a 5 percent increase in volumes. Roche AG's China sales increased 4 percent, generating $1.6 billion in 2015, while in the fourth quarter, Merck & Co. Inc.'s sales grew 2 percent, compared to the same quarter the previous year.
Not surprisingly, Glaxosmithkline plc was the hardest hit last year as it struggled to regain footing after a corruption scandal that led to a complete compliance overhaul of its sales force: GSK's sales contracted 18 percent year-over-year (y-o-y) in 2015. According to BMI Research, "for Q415, the firm noted a 26 percent y-o-y decline in sales due to pricing policies, business restructuring and the disposal of peripheral parts of its product portfolio."
Not that every global pharma is now scraping the bottom of the growth barrel in China. Pfizer Inc.'s China revenues grew 10 percent y-o-y in 2015, while Sanofi SA enjoyed 19 percent growth, raking in sales of $2.4 billion.
But Astrazeneca plc comes out on top in terms of growth, with a 13 percent gain, generating $2.5 billion in revenues in 2015. Astrazeneca's asthma drug, Pulmicort (budesonide inhalation), grew 43 percent to contribute $485 million in sales and Brilique (ticagrelor), a drug used to prevent blood clots to ward off heart attacks or strokes, increased 38 percent to bring in $218 million in sales.
While growth in China is more robust than in the developed markets – an anemic 3 percent growth has become the benchmark – China is becoming an increasingly complex and fraught place to operate.
BMI Research points to several factors and urges caution: the continued downward pricing pressure as the government tries to afford expanding health care coverage; and regulatory reforms – still a work in progress – that do not make clear a reliable timeline for expedited review. There's also the politically fueled corruption campaign that shows no signs of abating and is a major concern for executives, given the inconsistent compliance enforcement.
For pharma CEOs that have grown accustomed to telling investors that China will bring double-digit growth, where should they turn?
COUNTY-LEVEL HOSPITALS: THE NEXT BIG THING
Chinese cities have long been segmented by tier though there are no hard and fast rules – tier 1 denotes China's biggest, richest, most developed cities close to the coast such as Beijing, Shanghai, Guangzhou and Shenzhen. Tier 4 and 5 cities are located further inland and suffer from fragmented markets hampered by difficult logistics and distribution.
But with China, where size always matters, it is notable that tier 5 cities, according to 2011 Nielson's numbers, account for 169 million households, or ¥4 trillion (US$610.6 billion) in income value. By comparison, tier 1 cities accounted for 16 million households and ¥1 trillion in value.
If companies are looking for a slice of the China market that is growing at 20 percent, PwC suggests going even further inland, to tier 6 and 7 cities, where there are 1,700 counties worth exploring.
"This market bears great opportunities but also carries unique challenges," said PwC consultants in a report published at the end of 2015.
According to PwC, "going forward, in the light of saturation of tier 1 and tier 2 cities, the government will continue to expand its health care coverage at the county level. The county segment is expected to become the largest sector of [the] China pharmaceutical market and will fundamentally change the current configuration."
By 2020, PwC predicts that county-level hospitals (tier 6 and 7 cities) will have 40 percent market share. By comparison, it is predicted tier 1 and 2 cities will have 20 percent to 25 percent of the market in 2020.
UNCHARTED TERRITORY: MAKING COUNTY-LEVEL SALES WORK
Beyond those drugs on the essential drugs list (which at the county level hover around 20 percent for top [class III] hospitals), distributors have typically dominated at the county level, with few Chinese drug companies directly servicing those markets, not to mention global ones.
Barriers pharma companies will have to overcome include affordability issues; rural insurance schemes do not protect patients from sizable out-of-pocket expenses for drugs even though incomes are low. In tier 6 and 7, PwC predicts about 10 percent to 15 percent of the patient population can afford to self-pay for medications, while the vast majority (60 percent to 70 percent) are reliant on the National Rural Medical Cooperative system.
But the toughest issue in those markets is most likely compliance risk. PwC said greater medical education about drugs for doctors is needed at the county level and that leads to heightened compliance risk. The vast majority – 80 percent to 90 percent – of tier 6 and 7 hospitals are under a zero mark-up policy and are supposed to be aligned with government's centralized pharmacy management program.
Consultancy firm Control Risks' senior managing director for Greater China and North Asia, Kent Kedl, urges companies to take a strategic view of compliance – and not relegate it solely to operations-level decision-making . That means segmenting markets not just by growth potential but also by corruption risk. A clear assessment of the risk may mean walking away from some growth if necessary – but if not, companies should be willing to invest heavily to ensure squeaky clean sales.
Ultimately, those that go after the county-level hospital opportunity will have to be highly innovative, said PwC, to ensure compliance as well as to disrupt the entrenched logistics and distribution channels by inventing new ones.