Selling Drugs Is No Longer a Free Lunch in China

(Bloomberg Opinion) -- There may be such a thing as a free lunch in China's pharmaceutical industry. It turns out it's not an unlimited buffet, though.

For years, the country's largest drugmakers have happily sold low-cost generic medicines yielding gross margins of 80 percent to 90 percent without giving much thought to consumer protection or innovation. It's not uncommon for pharma companies to spend one-third of their revenue on sales and marketing, while shelling out peanuts on research and development of new drugs.

The bonanza has been so lucrative that medical school graduates would be better off selling drugs than becoming doctors. Just five years ago, Chinese took 10 times the amount of antibiotics consumed by Americans, fanning the rise of superbugs. Salespeople from pharmaceutical companies swarmed from hospital to hospital pushing doctors to prescribe their medications. Public hospitals were happy to oblige; they were allowed to charge a 15 percent markup on drug sales.

But now, these cash cows are being forced to fast.

Starting this year, governments of 11 cities will take over procurement of drugs for their hospitals. They will give at least 60 percent to 70 percent of orders for 31 specified, mostly generic, treatments to the lowest and best-stocked bidder. With a rapidly aging population and 4 million new cancer patients each year, China is playing tough. The state's basic medical insurance program is burdened with ballooning expenses and is estimated to run into deficit as early as 2020.

A fierce price war has ensued. The average tender price in the 11 pilot cities was 55 percent lower than the previous auction, according to results announced Dec. 7. Sino Biopharmaceutical Ltd. slashed the price of its hepatitis treatment entecavir by more than 90 percent to beat out Bristol-Myers Squibb Co. and two local competitors. The drug has accounted for 16 percent of Sino Biopharm's sales in 2018.

At this rate, China's drugmakers can say goodbye to most of their profits. At 3SBio Inc., for example, more than 60 percent of its revenue comes from drugs that have at least five direct substitutes in the market, according to estimates by CLSA Ltd.

After a bruising vaccine scandal in July, Beijing is starting to have second thoughts about the quality of generic drugs produced at home. China has more than 4,000 generics that have yet to go through the government's bio-equivalence tests. As of October, out of 289 drugs that the government deems essential, only 7 percent passed.

Authorities are also opening the door to foreign pharma giants as they seek to pacify a rising middle class that demands the best medicines. Under a guideline published in July, generic drugs that have passed bio-equivalence studies overseas will be able to submit an abbreviated application in China. In other words, they will be fast-tracked.

Some Western drugs got swift approval last year; in 2019, we may well see the arrival of India's generic drugmakers.

There's nothing wrong with big profits. But pharma companies in developed markets have plowed billions of dollars into research and are avid buyers of cutting-edge technology to justify their margins. Of biotech firms that raised at least $20 million in U.S. initial offerings, a remarkable 30 percent were subsequently acquired.

China's big pharma firms have done little more than milk China's demographic dividend. It's time for them to sing for their supper.

To contact the editor responsible for this story: Matthew Brooker at mbrooker1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.