China's New Drug Price Policies Will Favor Big Distributors, Restrict Smaller Ones

SHANGHAI - China is releasing a series of new policies to fight bribery in the pharmaceutical industry and reduce drug prices, which will benefit large distributors such as SinoPharm, Shanghai Pharmaceutical Group and Jointown, said an expert in a Citi research conference call July 19.

The Chinese government is cutting drug prices deeper following massive drug price reductions in 2007. The new price reduction, together with the release of draft guidelines on drug pricing, is believed to be related to recent Chinese media reports about hospitals selling drugs at 13 times their ex-factory prices (Also see "Public Criticism Puts Pressure On Chinese Government To Reduce Drug Prices" - Scrip, 29 Jun, 2010.).

China has reduced drug prices 24 times in the past decade, Niu Zhengqian, the vice general manager of the largest private distributor Jointown, told investors during the Citi conference call.

"The philosophy of the new guidelines is the same as the old version, which was released in 2000. Therefore, it won't change the situation, if the government doesn't roll out a stronger enforcement measure," added Niu, who is also vice chairman of China's Pharmaceutical Enterprises Association.

The new guidelines have stricter rules on profit margin ceilings for drug makers and locks in mark-ups for distributors, which will "force the smaller distributors to change their business models, while it will have no negative impact on the large distributors," he noted.

More than 13,000 smaller distributors in China rely on commissions to survive, while large distributors rely on a distribution fee and kickbacks from pharmaceutical companies, Niu said.

"The large distributors' gross margin is roughly 5 to 10 percent and net profit is only 3 percent of the retail price, which is already much below the mark-up ceiling set by the National Development and Reform Commission," said Niu, who pointed out the gross margin for smaller distributors is more than 20 percent.

This will benefit the large distributors and drug companies with in-house sales teams by earning more market share from smaller players.

The final guidelines are expected by the end of this year, according to Niu.

In a July 19 research note to investors, Citi analyst Richard Yeh singled out likely winners as local pharmas targeting first-to-market generics, like Jiangsu Hengrui, over-the-counter manufacturers with strong brand names, like Dong A-A Jiao, and prescription drug developers with strong sales forces such as Simcere. The new guidelines will have limited impact on multinational pharmas, Yeh predicted.

New Medical Reimbursement System Pilot In Beijing

While ongoing price reductions may have little effect on exorbitant prices for some drugs, a new medical reimbursement system might help solve the problem.

The new system pays hospitals according to diseases, which severs the relationship between hospital income and drug sales. In Beijing, the government is piloting the new system in a few public hospitals for 56 selected diseases. In 2011, the pilot project will be expanded to all the top public hospitals in Beijing, Niu said.

The new system will minimize the incentive for doctors to overprescribe drugs, which is "bad news" for pharmaceutical companies, he said. However, generics with lower prices and higher efficacy as well as innovative drugs and first-to-market generics will be the biggest winners of the new reimbursement system.

A Tale Of Two Distributors

Large distributors are quickly expanding their distribution networks to facilitate larger market share, as the new healthcare system allows only one distributor per region for drugs on China's essential drug list.

State-owned giant Sinopharm, which raised more than $1 billion from its initial public offering in Hong Kong last year (Also see "The Year Of The Tiger Looking Strong For IPOs In China Following Sinopharm Success" - Scrip, 4 Dec, 2009.), is spending that money on acquiring local distributors.

Backed by Sinopharm's large scale of products, acquired companies can easily become top distributors in their regions, Niu commented.

Jointown, the largest private distributor, became the industry leader by its "quick sales" model, which offers lower prices to local distributors, clinics and pharmacies to trade for higher sales volumes and higher kickbacks from pharmaceutical companies.

Jointown relies more on organic growth by building up its own facility to compete with existing local distributors, according to Niu. He said Jointown could become one of the top five regional distributors in three years using its "quick sales" model.

- Dai Jialing ([email protected])