Selling drugs is no longer a free lunch in China

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 per cent to 90 per cent 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 per cent 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 per cent to 70 per cent of orders for 31 specified, mostly generic, treatments to the lowest and best-stocked bidder.

With a rapidly ageing population and four million new cancer patients each year, China is playing tough. The state's basic medical insurance programme 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 per cent lower than the previous auction, according to results announced on Dec 7. Sino Biopharmaceutical Ltd slashed the price of its hepatitis treatment entecavir by more than 90 per cent to beat out Bristol-Myers Squibb Co and two local competitors.

The drug has accounted for 16 per cent 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 per cent 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.

Pacifying a rising middle class

As of October, out of 289 drugs that the government deems essential, only 7 per cent 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 US$20 million in US initial offerings, a remarkable 30 per cent 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. BLOOMBERG