What Does China's Price Manipulation Ruling On Unilever Mean For Global Pharma? (Part 2 of 2)

[Editor's note: This is part two of a two-part feature; part one covered the background of China's National Development and Reform Commission charge against consumer goods company Unilever and what multinational companies operating in China should take away from the incident. This second part looks at the larger impact of China's inflation on pharma companies.]

[Editor's note: This is part two of a two-part feature; (Also see "What Does China's Price Manipulation Ruling On Unilever Mean For Global Pharma? (Part 1 of 2)" - Scrip, 19 May, 2011.) covered the background of China's National Development and Reform Commission charge against consumer goods company Unilever and what multinational companies operating in China should take away from the incident. This second part looks at the larger impact of China's inflation on pharma companies.]

In an inflationary climate, China's consumer price index rose more slowly in April - 5.3% - than the 5.4% rise in March, but it still remains the second-sharpest increase in three years.

In an effort to curtail inflation, NDRC has met with 17 industry associations involved in consumer products to try and influence them to maintain stable prices.

As a result, the All China Federation of Industry and Commerce recently released an open letter urging its members not to raise prices or manipulate supplies. The letter was co-signed by 24 sub-associations of the federation that included the Medical and Pharmaceutical Commercial Association, which called on its members to voluntarily ensure stable supplies and prices.

"The Unilever incident signaled the government's determination to stabilize prices, and under the strong tendency towards lower drug prices, no pharmaceutical companies would take the risk to increase prices," Convoy law firm's Chai Hua predicted, noting " there is no such giant like Unilever in China's pharmaceutical market."

As production costs rise, global pharmaceutical companies can more easily absorb the impact on revenues than smaller Chinese drug makers, according to Chai.

Although that may be true, it has not stopped the R&D Based Pharmaceutical Association Committee (RDPAC), which represents Big Pharma in China, from complaining about recent government-mandated price cuts that are doubly hard to swallow in an inflationary environment (Also see "Are China's Rising Labor Costs Good For Big Pharma?" - Scrip, 11 May, 2011.).

Pharma Options For Dealing With Inflation

According to Chai, the large number of drug manufacturers in China also encourages price competition and decreases the chance of price hikes, even when companies face increased costs in logistics and distribution following NDRC price hikes on items like on gasoline.

As oil prices increase, distribution cost pressures increase, which will have a significant effect on manufacturer profitability, according to Chai.

Local pharma companies may have to shorten their logistic chains or make other product adjustments to turn a profit, he suggested.

For example, this month beverage giants Coca Cola and Pepsi reduced the size of their packaging from 600 ml to 500 ml in China in an effort to rein in costs without raising prices, but pharma companies cannot change specifications so easily.

However, package downsizing could be an option in the OTC drug industry, Dermot Zhang, Shanghai-based Partner with Haworth & Lexon, told PharmAsia News. "For OTC and consumer health products, if a company gives clear indication of the content, it is lawful and it will be the consumer's choice to buy [a product] or not after the company changes the packaging."

NDRC Taking Actions Against Independent Pricing

The Chinese government also uses non-market means to control price changes and comfort consumers, Zhang said, noting that the government would generally communicate with industry before announcing price hikes.

To encourage foreign companies to bring more innovative medicines into the Chinese market, foreign drugs are usually eligible for independent pricing and for many years were exempted from China price reductions. But recently NDRC has taken steps to reduce the special treatment afforded to foreign companies.

In July 2010, for instance, the NDRC issued a draft version of new regulations on drug pricing in which independent pricing powers of some innovative drugs with higher production quality would be revoked. The new regulations are expected to considerably affect foreign pharmaceutical companies.

And, in March, NDRC cut the maximum retail price of 35 drugs on China's Essential Drug List and 127 on the National Drug Reimbursement List - 1,265 formulations in total - by an average 21%, aiming to combat inflation, which affected MNCs including Pfizer Inc., Novartis AG, GlaxoSmithKline PLC and Sanofi (Also see "Big Pharma Takes Another Haircut As China Slashes Drug Prices In Two Largest Therapy Fields" - Scrip, 8 Mar, 2011.).

"As domestic pharma companies keep progressing, and preferential tax policies for foreign companies are canceled, domestic companies and MNCs are on the same platform of competition," said Chai. "Foreign companies in China are being treated the same as Chinese domestic companies."

"So far, NDRC's track record in the antitrust field does not suggest that foreign companies are more targeted than domestic ones," Hogan Lovells attorney Adrian Emch concurred. "In the past few years, most companies subject to antitrust decisions issued by NDRC were Chinese players."

This is different from other fields of Chinese antitrust law, he noted. In the merger control area, almost all adverse decisions adopted by the Ministry of Commerce involved foreign companies, including pharma companies Pfizer and Novartis (Also see "As China's Anti-monopoly Laws Go Into Effect, Rigorous Enforcement Could Apply To Deals On The Table" - Scrip, 2 Feb, 2011.).

Still, the fine imposed on Unilever is higher than the fines imposed on domestic companies in the past, according to Emch.

Global companies will find it difficult to retain higher prices for their innovative products if they want to place them on China's reimbursement lists as further price cuts are anticipated. However, many analysts predict that Chinese price cuts might actually be beneficial in the short run, with companies making up in volume what they will lose in price (Also see "Are Chinese Price Cut Fears Overstated? Volume Likely To Drive Pharma Industry Growth, Analysts Say" - Scrip, 23 Dec, 2010.).

In addition, some analysts predict that price cuts could encourage MNCs to bring more innovative drugs to China in an effort to regain premium pricing. Although Big Pharma has benefited through the years from independent pricing, in reality many of the drugs sold in China are older medications that have been off-patent in the West for years (Also see "China's NDRC Releases First Set Of Price Cuts; MNCs See Deepest Cuts As Expected" - Scrip, 1 Dec, 2010.).

It also turns out there may be a silver lining to China's inflationary pressures. Some analysts, like Morgan Stanley's Bin Li, are predicting that the China healthcare sector could soon become a preferred safe haven for Chinese investors looking to hedge against an inflationary environment, helping the sector rebound from a poor first half.

- Ying Huang ([email protected])