China’s health care market is growing rapidly, and that is good news and bad. The bad news is that it means China is an increasingly unhealthy place to live. A country that once had trouble feeding itself now has a fat energy supply ratio of 35%, 5% over the World Health Organization’s recommended limit. Liver diseases – in particular, forms of hepatitis – are exploding; horrific pollution levels are producing cancer clusters. Not to mention the fact that China consumes nearly one-third of the world’s cigarettes. And by 2040, there will be 397 million Chinese people over the age of 60, 28% of the total population. Combine all that with a new health insurance system that proposes to cover 95% of the population, and you have a lot more people buying drugs. The question is, whose drugs will they buy?
China is now expected to be the world’s second- or third-largest pharmaceutical market by 2015. Pharmaceutical research firm IMS Health predicts that pharma revenues in China will reach US$40 billion by 2011. Unfortunately, the Chinese pharmaceutical industry is not well-positioned to exploit this opportunity. At present the domestic sector is still in a copycat phase producing generic drugs; domestic innovation has been slow.
Speaking at a pharmaceutical research and development conference held by IBC Life Sciences in Shanghai in April, Peng Cho Tang, the chief scientific officer at pharmaceutical firm Shanghai Hengrui, noted that most of the drug patents being filed in China are still filed by foreign firms. "In one hot research area, of the 200 patents filed, only 15 were by Chinese companies," he said. "We need to change the mentality."
Frank Jiang, head of research in China for Sanofi-Aventis, concurred: "A minority of [domestic] companies – less than 5% – are innovative, and most of those are engaged in formulation modification of traditional Chinese medicine. We need to change the mindset from manufacturing to innovation."
"The government clearly wants to encourage innovation in the pharmaceuticals industry," said Tony Chen, a lawyer specializing in life sciences at Jones Day in Shanghai. He noted that the law has many positive improvements. For example, patent hijacking loopholes have been closed by adopting Europe’s "absolute novelty" standard.
But all news is not good. "Unfortunately there are two new clauses in the new law that discourage foreign pharmaceutical companies from conducting inventive activities in China," said Chen. The first clause is the pre-foreign filing secrecy review process that could take four to six months; violation would result in loss of patent protection in China. Second is the caveat that any unwitting violation of unspecified laws and regulation in obtaining and using genetic resources in China may render the related Chinese patent invalid. Such vagueness makes research firms nervous.
Making it easier to overturn patents may be good for the generic manufacturers in the short run, but the problem is that the new health care system will not necessarily support the margins they once enjoyed. Rajesh Parekh, leader of Asia health care practice at McKinsey, said that inclusion on the Essential Drug List (EDL, the list of drugs to be provided at controlled prices through the health care plan) is a mixed blessing, as it will come with increased government pressure to reduce prices. It will also force out many copycats.
"There will be huge pressure to differentiate," Parekh said. "Why should the government list your molecule on the EDL instead of the other guys?"
This isn’t to say money can’t be made in generics, at least in the medium term. The loss on margins may well be made up by volume, said Parekh, who pointed out that two-thirds of Beijing’s new health care spending will be directed at the demand side. But rules issued in some of the bigger cities limiting the number of brand names permitted to peddle same molecule – two or three in some instances – may encourage a degree of consolidation.
Regardless, both Chinese and multinational companies need to become more innovative in China, and the multinationals don’t hold all the creative cards. "A lot of multinationals in China have been coasting on an aging portfolio," said Parekh. "This will go away."
And while China’s cheap labor costs and easier drug trial regulations still support generics, the labor advantage can also play out in the direction of new discovery.
A venture capitalist at the IBC conference noted that in the US, VCs encourage small drug research companies to focus on a single product, which minimizes labor costs but means each company makes a "binary bet." Either the drug is approved or the company goes out of existence. Chinese companies, on the other hand, have the luxury of hedging their bets by pursuing multiple opportunities at once.
Complicating the balance sheet projections, however, are concerns that renminbi appreciation will destroy China’s cost advantage when it comes to exporting. "If the renminbi goes up, that will completely change the core strategy," said Jiang of Sanofi-Aventis.