‘Painful’ consolidation ahead for China’s generic drug makers, as Beijing gets behind procurement revamp

  • 52 per cent difference in price on average between winning bids under centralised bulk drugs procurement pilot and last year’s lowest prices for the same drugs
PUBLISHED : Monday, 17 December, 2018, 8:22am
UPDATED : Monday, 17 December, 2018, 7:24pm

Can Chinese generic drug makers remain profitable under Beijing’s new state procurement mechanism that has already led to a fall in average selling prices by more than half?

Yes they can, according to analysts who say tender winners will be able to offset the impact of lower prices through savings made possible by bigger volumes and the elimination of hefty distribution costs under the current, distorted pricing mechanism.

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“Winning prices in this [new] round of centralised procurement are not the result of unreasonable reductions,” Jin Hong, an analyst at Guoyuan Securities, says in a report. In the previous system, a lot of distribution costs were incurred to push sales, “resulting in a huge gap between ex-factory and end-user costs”, sometimes as high as dozens of times.

Jin is referring to a 52 per cent price cut on average between winning bids under China’s first centralised bulk drugs procurement pilot conducted a week ago, and last year’s lowest prices for the same drugs.

According to Jin, the new system will usher in a period of “painful adjustment and consolidation” for the generic drug industry in China, resulting in a smaller number of more capable and innovative companies in an industry with more than 600 players.

Although the winners will still be profitable, the original, over 30 per cent net profit margins enjoyed by producers will no longer be maintained
Lin Xiaowei, analyst, Everbright Securities

The price falls ranged between 13 per cent and 96 per cent for the 25 drugs tendered. The tenders for six other drugs attracted no viable bids and were withdrawn.

It was the first round of bulk purchase tenders and covered 11 cities, with the volumes accounting for about 30-40 per cent of drug makers’ total annual procurement volume. If proven successful, bulk tendering is expected to be gradually rolled out countrywide.

Procurement is fragmented along layers of distributors that mark up costs to hospitals, which rely heavily on drug sales profits to make up for losses in patient care services.

Jin estimates that transaction, distribution, selling and financing costs, as well as kickbacks, altogether make up between 43 per cent and 75 per cent of end user drug prices under the current system.

Under the “all-or-nothing” and “lowest-price-wins” characteristics of the new system, the winners will be allotted up to 70 per cent of market share for each product.

By squeezing out selling costs – much of them kickbacks to drug prescribers and hospital administrators – and ramping up winners’ production scales, it is expected major savings could be achieved. But this will not prevent the erosion of major profit margins.

“Although the winners will still be profitable, the original, over 30 per cent net profit margins enjoyed by producers will no longer be maintained,” says Lin Xiaowei, an analyst at Everbright Securities. “The losers will fare even worse, as they face a shrunken addressable market and intense price rivalry.”

Shares in Chinese makers of generic drugs – cheaper alternatives of original innovative drugs allowed to be sold after the expiry of patents – have plunged following the introduction of the pilot programme.

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The Hang Seng Mainland Healthcare Index, which tracks 31 stocks with a combined market value of HK$672 billion (US$86.05 billion) and comprises mostly generic drug makers and distributors – has fallen by 32 per cent from a peak in late May this year. The benchmark Hang Seng Index has, in comparison, dropped by 14 per cent in the same period.

Through competition, Beijing aims to substantially lower drugs costs and increase their accessibility, while improving their quality and cutting overprescription.

All drugs taking part in the tenders must undergo tests to ensure their efficacy and safety, and be subject to future inspections. Hospitals have also been given incentives to keep some savings from the procurement system revamp to improve doctors’ compensation.

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But the pace of the roll out of the new system countrywide is uncertain, with some analysts less sanguine than others.

“Going into 2019, we remain observant on the national implementation of bulk procurement, as we see prescribing doctors being the biggest resistance, given their kickback benefits are harmed,” Citi analyst John Yung writes in a note.