From today’s Asia Times, my column on how the Anhui pharma model is spreading throughout the country and whether it might impact China’s medical device and diagnostic sectors as well. The article can be read by clicking here, and is quoted below from Asia Times:
Anhui medicine wrong for China
ByFew issues in China better illustrate the poverty in which most Chinese live than their inadequate access to modern healthcare. These problems shed light on growing tensions between the urban and rural populations as well as the health implications to China’s high-velocity encounter with modernity.
Throughout Beijing’s 12th Five-Year Plan are numerous acknowledgements in the forms of incentives and relaxed standards on foreign investment all designed to bring outside expertise into the healthcare market while encouraging the development of domestic capabilities in these areas.
Towards the end of 2011, JPMorgan published a report that identified a plan of the Chinese government to build thousands of hospitals and upgrade many more. As most industry experts agree, even if China is successful with this massive build-out, it still will not be enough to meet the country’s exploding healthcare demand.
Beyond the need for physical infrastructure and the equipment to finish out these newly built facilities loom even larger questions, how will the government pay for the healthcare needs of its people? For a very poor country with a centralized healthcare scheme, meeting even baseline needs will itself be expensive, let alone the much greater expenses anticipated as Chinese come to understand that certain types of cardiovascular conditions, communicable diseases and cancers are treatable by modern medicine.
An equally problematic question is how China will provide the human capital necessary to deliver healthcare around the country. In a country where the government estimates it needs some 200,000 pediatricians in this specialty alone, a shortage in skilled medical workers remains a major problem.
In the past year, doctors in China who have become frustrated at their pay have been leaving their hospital practices to join pharmaceutical companies as sales representatives, a move that likely played a small role in Beijing’s 2011 decision to allow doctors to begin practicing one day a week at private hospitals where they can make more money.
Beyond the challenges of expanding China’s healthcare infrastructure and the human resources it will require is the question of how the country can afford to offer basic pharmaceuticals if it is successful in adding to the number of doctors within the system at the same time Chinese come to understand the various maladies made treatable by modern drugs.
Making Beijing’s national policy towards pharmaceuticals even more complicated, is that for years the central government has allowed doctors and hospitals to generate (40-50%) of their revenues and a significant percentage of their operating profit by marking up drugs prescribed by the physician and dispensed by the hospital.
The over-arching need from Beijing to improve the quality and effectiveness of healthcare runs at perverse cross-purposes with its need to incentivize doctors in ways that do not add to the central government’s crippling healthcare expenditures and lead to over use of such drugs as antibiotics.
As Beijing’s early attempts at healthcare reform have advanced, it has become increasingly obvious that pharmaceuticals remained an area where prescription and pricing abuse were all too common. The country badly needed a pharmaceutical policy that centralized purchasing power, thereby reducing costs, while addressing the over-and-under prescription of drugs made common by Chinese hospitals that saw drug disbursement as an important profit center.
In an attempt to address these competing priorities, the central government allowed the province of Anhui to pursue its own model for controlling the costs of pharmaceuticals distributed by the state’s healthcare system. Unlike the Shanghai model, rolled out in early 2011, the Anhui model is fixated on getting the lowest cost possible without – at least as critics suggest – adequate consideration of the relationship between price, benefit and quality.
The Shanghai model attempts more of a balance in this regard, and in particular pays more attention to matters of quality, but thus far it has not received the attention that the Anhui model has. As of today, 18 of China’s 23 provinces have adopted all or part of the Anhui model, a trend that has many multi-national pharmaceutical companies worried.
The Anhui model broadly consists of two elements: first, a requirement that prescribing institutions have a 0% mark-up on drugs called out on the Essential Drug List (EDL) and second, a formalized and centrally controlled bid and purchase process for drugs on the EDL.
George Baeder, a Shanghai-based Partner at Monitor Group Asia, is an expert on the Chinese pharmaceutical market. Baeder emphasized that not all parts of the Anhui model have been equally adopted by every province.
“In the industry, people generally are referring to the two-envelope bids instituted in provincial tenders for EDL drugs in Anhui, which has spread to more than a dozen other provinces and to non-EDL drugs.” He went on to state that, “The problems created by zero mark ups can also exist in provinces that do not have a two-envelope bidding system.”
The two-envelope bidding system is designed to establish two gates that a successful bid must go through: the first envelope supposedly ensures that the companies bidding on a given drug on the EDL have the technical capabilities and quality control protocols in place and the second envelope is entirely focused on price.
Unlike some, Baeder does not believe the two-envelope process is inherently flawed; rather, the problem revolves around how the product set included in the tender is defined and how thoroughly the first envelope is evaluated. As designed, the first envelope should constitute a gate that, as he says, “Disqualifies products that are low quality, cannot be delivered in sufficient volume, or in a timely matter.”
But, what Baeder and others see happening is that this first envelope is given only a cursory review that rarely disqualifies any vendor from bidding during the second stage. Consequently, “few of the bidders are disqualified on technical grounds and therefore there is a big incentive to compete solely on price by dropping quality standards.”
As designed, the Anhui centralized bid and tender model would have consolidated volume, allowing manufacturers to bid at lower prices but make up with increased quantity what they were losing on individual gross margin. While the Anhui model has been successful driving costs down, it has been equally successful rewarding business to less-scrupulous drug manufacturers that have cut corners and dropped quality standards in order to try to make money.
“Since both patients and physicians are keenly aware of this deterioration, many now distrust EDL medicines and prefer to pay a premium for brands that they recognize,” says Baeder.
Michael Zakkour, a principal at Technomic Asia, a China-based consulting firm, has worked extensively in China’s pharmaceutical space. He notes that, “The results are already in. The share prices of domestic drug companies in China are down an average of 25-30% and the share prices of foreign pharma companies with interests in China are down.”
As Zakkour said, “[the Anhui model] will impact profits along the entire supply chain, from manufacture, to distributor, to retail.”
Not only has the Anhui model forced certain drugmakers to the sidelines while others have chased a downward spiraling price, Baeder notes that “Some EDL drugs have disappeared from tenders because tender prices have been below cost and either no one bids or the winning bidder cannot supply at the promised price.”
In addition, because the Anhui model seeks to control costs not only by lowering reimbursement prices paid for drugs but also by requiring a 0% mark-up by the local hospitals and healthcare clinics, in some cases the products are never locally stocked. Baeder said that in many cases, “The clinic cannot afford to stock products on which it cannot make money; distributors don’t want to carry them because they cannot make money … and doctors won’t prescribe them because they either do not trust the products or cannot make money on them (or both).”
Obviously, multinationals have many reasons to be wary of the Anhui model. Thus far, according to Baeder, multinationals have not been hurt as much as domestic drug producers have. This is because, according to him, “the [multinationals] have fewer drugs in the EDL. Most still have 60-70% of their revenues from branded generics, most of which are reimbursed, but not included in the EDL.”
Baeder said the Anhui model’s emphasis on a two-envelope bidding process was beginning to spread beyond the EDL into non-EDL pharmaceuticals, a move that could ultimately accelerate price-gouging pressures and hurt American and European drug companies.
Zakkour noted that not only does the Anhui model set in motion the pricing pressures Baeder referenced at the provincial level; it also muddies the water nationally. Because the Anhui model forces a province-wide set price and rewards all of the business to one manufacturer, Zakkour says ultimately this means “US and EU pharma companies compete on price, against generics, thus eliminating their most important differentiator and profit center.”
The net is that while the Anhui model has been successful driving cost out of the system, it has done so in a way that has discouraged larger more sophisticated pharmaceutical companies from viewing China as a growth opportunity. Yes, the potential volume in a largely un-tapped market is enormous, but so too are the pricing risks if the central government does not put in place a more balanced plan for dealing with increased costs due to expanded coverage.
While both domestic and multinationals in the pharmaceutical sector grow increasingly fearful that the Anhui model will further expand, they remain hopeful problems with the model will be noted and changes will be made allowing for more flexibility. The 2011 promotion of Sun Zhigang from his status as vice governor of Anhui province to be the director of the Office of Health Reform suggests the Anhui model is likely to be the template for further healthcare reforms in China over the short-term.
This troubles more than just pharmaceutical companies. Medical device and diagnostic companies that desperately want into the growing Chinese market are equally concerned. They realize how quickly the Anhui model could be deployed towards their products with similarly disastrous results.
The Anhui model has, at its core, the best of intentions: lowering costs, streamlining purchasing processes, and expanding coverage of life saving pharmaceuticals to more Chinese. However, in its current form, the Anhui model provides many disincentives to both domestic and multinational pharmaceutical companies that desperately need the Chinese market to continue opening and extending coverage to many urban and rural Chinese only now beginning to understand the great good modern medicine has in store for them.
Benjamin A. Shobert is the Managing Director of Rubicon Strategy Group, a consulting firm specialized in strategy analysis for companies looking to enter emerging economies. He is the author of the upcoming book Blame China and can be followed at www.CrossTheRubiconBlog.com.
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