A perspective devoted to the evolution of the Pharma market in China. By Daniela Scaramuccia, Partner

1. PHARMA MARKET
IN CHINA MULTI-
NATIONALS’ REAL
CHALLENGE
IS TO ANTICIPATE
GOVERNMENT
MEASURES AND
ENJOY GROWTH
PERSPECTIVE APRIL 2013
Daniela Scaramuccia, Valentina Gorgoglione, Maurizio Minelli

2. Pharma market in China.
Multinationals’ real challenge
is to anticipate government measures
and enjoy growth
Published by
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April 2013
Written and edited by:
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Maurizio Minelli
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3. PERSPECTIVE PHARMA MARKET IN CHINA
OVERVIEW 5
LATEST EVOLUTIONS OF THE CHINESE
PHARMACEUTICAL MARKET 7
THE GENERICS EXPANSION AND THE CHALLENGE
OF THE INNOVATION 13
PRICE PRESSURE 15
AN INCREASED ATTENTION TO COMPLIANCE 17
AUTHORS 18
CONTENTS

4. 4 – 5
8.000 Bln dollars GDP and
more than 1,3 bln population:
a few numbers that explain
why China has represented
“the place to be” for most
of the MNCs.

5. PERSPECTIVE PHARMA MARKET IN CHINA
8.000 BLN DOLLARS GDP AND MORE THAN 1,3 BLN
POPULATION: A FEW NUMBERS THAT EXPLAIN WHY CHINA
HAS REPRESENTED “THE PLACE TO BE” FOR MOST OF THE
MNCS.
THIS IS EVEN MORE TRUE WHEN TALKING ABOUT “BIG
PHARMAS”. IN FACT, CHINESE HEALTHCARE MARKET
ACCOUNTS FOR ~400 BLN DOLLARS AND GROWS WITH A
DOUBLE DIGIT RATE. SEVERAL PHENOMENA LET US FORESEE
AN IMPRESSIVE GROWTH RATE OF THE PHARMACEUTICAL
MARKET ALSO FOR THE YEARS TO COME: IN PRIMIS, THE
ON-GOING REFORM MEANT TO ENSURE AN UNIVERSAL
INSURANCE COVERAGE. MOREOVER, THE EVOLUTION OF THE
POPULATION LIFE-STYLE, BECOMING RICHER, OLDER AND
MASSIVELY MOVING FROM COUNTRYSIDE TO MEGALOPOLIS:
ALL CONDITIONS THAT INCREASE THE NEED FOR MEDICAL
CARE.
WARNINGS ON HOW THE SCENARIO COULD NEGATIVELY
EVOLVE FOR PHARMA AND HEALTHCARE MULTINATIONALS
IN CHINA HAVE ALREADY BEEN HIGHLIGHTED. GENERICS,
FOR INSTANCE, HOLD AN INCREASING SHARE OF
THE MARKET, REDUCING THE VALUE AT STAKE FOR
MULTINATIONALS. IN ADDITION, THE CONTINUOUS ROUNDS
OF PRICE CUT THAT THE GOVERNMENT IS IMPLEMENTING IN
ORDER TO REDUCE THE “COST TO PATIENT” ARE ESPECIALLY
PENALIZING NON-LOCAL COMPANIES, WITH A TANGIBLE
NEGATIVE IMPACT ON MULTINATIONALS’ MARGINS.
OVERVIEW

6. 6 – 7
HOWEVER, WHO THINKS THAT THE SCENARIO IS STABLE
AND “CRYSTAL CLEAR” IS WRONG. THE GOVERNMENT
IS INTRODUCING, ALMOST ON A DAILY BASIS, MEASURES
THAT COULD WORSEN THE LEADERSHIP POSITION THAT
BIG PHARMAS HAVE GAINED THROUGHOUT THE YEARS
AND THE MANY INITIATIVES, PARTICULARLY IMPACTING
MULTINATIONAL COMPANIES, PLANNED DURING THE RECENT
NATIONAL PEOPLE’S CONGRESS ARE JUST AN EXAMPLE.
AS A MATTER OF FACTS, CHINA REMAINS “THE PLACE
TO BE”, BUT ONLY THE ONES WHO ARE ABLE TO ANTICIPATE
GOVERNMENT INITIATIVES AND TIMELY INTERVENE WILL
ENJOY GROWTH IN SUCH AN INTERESTING MARKET.

7. PERSPECTIVE PHARMA MARKET IN CHINA
LATEST EVOLUTIONS
OF THE CHINESE
PHARMACEUTICAL MARKET
Who thinks that the scenario
is stable and “crystal clear”
is wrong. The Government
is introducing, almost on a
daily basis, measures that
could worsen the leadership
position of Big Pharmas.
A GDP of almost 8.000 billion USD with
a double-digit annual growth, even if
with diminishing marginal increase, and
a population of more than 1,3 billion
people: these are just few reasons why
multinationals of any sector have de-
cided to invest massively in China since
the early 90s.
If China has represented the “place to
be” for companies of all sectors, this is
even truer for Pharma and HealthCare
companies. Let’s consider the market
dimensions, for example. The Health-
Care expenditure, accounting 121 billion
USD in 2004, was worth 386 in 2011:
this means an average annual growth of
18,1% versus much more limited growths
in mature markets.
Numbers that can explain the rush of
Pharma multinationals to China. But
there is more than this. These numbers
also explain why the turnover of Big
Pharmas in the Chinese market acquires
a growing relative weight in their port-
folios.
In fact, China is expected to become
one the top 3 countries for revenues in
each Pharma companies, mirroring the
position achieved as 3rd top HealthCare
market in the world. This appears even
more evident when comparing the rev-
enues growth rates of these companies
among different countries: in a period
of stable or limited growth, turnover
in China is experiencing a double-digit
growth.
Such a trend seems to be overwhelm-
ing. The HealthCare market, which is
expected to reach 1.000 billion in 2020,
is encouraging the Pharma giants not
only to be present, but also to massive
invest in China.
An example is Bayer HealthCare, target-
ing to grow more than 60% in Asia by
2015, pulled by the Chinese market,
accounting for more than 50% in the
region. On the other hand, Astrazeneca
is rethinking its global presence and
consolidating its business over three
poles: one of these, together with Lon-
don and Wilmington, will be in China,
and particularly in Shanghai. Moreover,
more than 20% of the Group hirings
in 2011 was performed in the Chinese
market.

8. HealthCare expenditure evolution in China, USA and Europe
2004-2011, USD billion
CAGR 2004-2011 (%)
2004
121
1.861
1.018
2005 2006 2007 2008 2009 2010 2011
138 157 184 231 279 318
386
1.988
1.086
2.121
1.173
2.254
1.238
2.360
1.316
2.451
1.388
2.547
1.403
2.646
1.480
2004 2005 2006 2007 2008 2009 2010 2011
2004 2005 2006 2007 2008 2009 2010 2011
18,1%
5,2%
5,5%
Note: exchange rate RMB/USD as of March 2013; EU includes EU 15 countries.
Source: China Statistical Yearbook 2012, OECD, Value Partners analysis.

9. PERSPECTIVE PHARMA MARKET IN CHINA
The drivers of this growth, and of the
strategic decisions that multination-
als are taking consistently, are the
socio-economic projections and some
initiatives launched by the Chinese
Government. The Pharma multination-
als, leveraging on their stable structures
and on a consolidated presence in the
country, can meet their strategic target
and enjoy the growth potential exploit-
ing some phenomena:
• A population who is getting richer
and a number of perspective re-
forms aiming at better-balancing the
distribution of the income. In fact,
the average income per capita is
expected to grow by 7% on average
every year from 2012 to 2015. And,
more than that, wealth is going to be
better distributed amid the popula-
tion, who will be able to get easier
access to medical care, increasing
per capita HealthCare expenditure.
Zheng Xinli, vice president of the
“China Center for International
Economic Exchanges”, has recently
declared that the Government’s first
priority is to expand the middle-class.
On February the 3rd 2013 the Coun-
cil of State released a preliminary
reform plan, whose details are not
available yet, according to which “a
more balanced income distribution
structure is expected to drive up
residents’ consumption rate by 10 to
15 percentage points, which means an
expansion of more than 1,1 billion USD
of consumption goods and services,
that can help to improve people’s
living standards”
• A population who is getting older. In
the past three decades, a dramatic
increase in life expectancy and a
severe application of the “only-child
policy” prompted the greatest de-
mographic transition in the world. As
a result, by 2050 about 30% of the
population will be over 60, against
a world average of 22%; more and
more people will need for medical
care
• A massive urbanization process.
About 70%, or 200 million people,
of the rural labor will move to cities
in the next 20 years, shifting to
the industrial and service sectors.
Together with a social and cultural
improvement, the impressive change
in life style will contribute to the
diffusion of some typical “well-being
diseases”. For instance, cardiovascu-
lar diseases, the first death cause in
China according to the New England
Journal of Medicine, are mainly
caused by diabetes, whose incidence
grows as life styles and food habits
change and become “metropoli-
tan”. Or other pathologies, such as
respiratory diseases and cancer, use
to spread with pollution, nowadays
the most recognized and discussed
problem affecting Chinese metropo-
lis as Shanghai and Beijing

10. Big Pharma growth evolution by region
Revenues growth 2011 vs 2010, %
0%
7%
11%
-4%
2%
-11%
8%
3%
7%
17%
34%
38%
15%
50%
Source: 2011 annual report, Value Partners analysis.
-2% -2%

11. PERSPECTIVE PHARMA MARKET IN CHINA
• A HealthCare reform aiming at
guaranteeing a basic assistance to
the whole population. Thanks to the
HealthCare reform implemented since
2009, more than 95% of Chinese
people has now some form of Health-
Care coverage, even if basic and with
a strong variance depending on the
province of origin. But the Govern-
ment initiatives continue following this
direction. The latest on March the 1st,
when the Council of State declared
the intention to create a fund, fi-
nanced jointly by the Government and
public donations, meant to guarantee
a medical coverage for chronic or
serious diseases even to those people
with no possibility to afford necessary
treatments, also through the diffusion
of hospitals / primary assistance cent-
ers in the rural areas
The Council of State declared
the intention to create a fund,
meant to guarantee a medical
coverage for chronic or serious
diseases even to those people
with no possibility to afford
necessary treatments, also
through the diffusion
of hospitals in the rural areas.
Despite these dynamics, it is not a mys-
tery that the boundaries multinationals
can operate within are getting tighter
and tighter also in the Chinese market.
This is due to the growing incidence of
local producers on one hand, as well as
to the regulatory environment, becom-
ing more and more severe especially
towards foreign operators.
Also the new Government seems to be
keeping the momentum: during the re-
cent NPC (National People’s Congress),
held within March the 4th and the 6th
2013, in fact, a series of priorities and
reforms was announced, highlighting
once again the intention to reduce the
“cost to patient” as to allow more and
more people to receive medical care. In
such a circumstance, in order to achieve
their strategic targets, multinationals
must definitely rethink their model of
presence in the medium-long term,
considering in particular three elements
that are shaping the Chinese Health-
Care market: the generics expansion
and the challenge of innovation, the
price pressure and an increasing atten-
tion to compliance.

12. Generics vs. brandend market share by hospitals type
Market share (volume), %, 2010
44% 56%
6%
AAA Hospitals
68%
32%
31%
AA Hospitals
Source: Asian Journal of Social Pharmacy, Value Partners analysis.
BrandedGenerics Weight on total hospitals
70%
30%
63%
A Hospitals

13. PERSPECTIVE PHARMA MARKET IN CHINA
1
Hospitals in China can be
of three types:
- A, primary hospitals = small
hospitals offering primary
assistance mostly in the rural
areas;
- AA, secondary hospitals =
medium-sized hospitals offering
services of general medicine;
- AAA, tertiary hospitals = big
hospitals offering specialist
services at a regional or national
level and represent specialized
research centers.
Besides, a fourth hospital
category exists: the 3AAA, more
specialized tertiary hospitals.
2
SKU=Stock Keeping Unit, the
minimum unit of a product type
that can be bought.
The Chinese HealthCare market is
already dominated by generics, whose
share is expected to grow even further
in the future. China, in fact, counts more
than 5.000 Pharma companies, about
98% of which produces generic drugs,
representing ~63% of the total sales.
The driver of local generic producers’
success against multinationals, together
with a looser and more aggressive com-
mercial behavior, is a very competitive
price, up to 10 times lower compared to
foreign companies. Lower prices repre-
sent the key success factor, especially
in a market where 95% of the hospitals
is second- and third-tier, while AAA1
hospitals’ number is expected to remain
marginal also in the years to come.
Furthermore, some reforms introduced
by the Government in the past years
supported the generics expansion.
Among these, the regulation preventing
a hospital to buy more than two SKUs2
of the same molecule: in this way, for
a matter of price, at least one product
out of two, even in AAA hospitals, is
generic.
Or even, the review of the patent law:
starting May 2012, the Government
of Beijing can issue licenses for the
production of generic versions of drugs
whose patent has not yet expired in
case of “national emergency or anoma-
lous circumstances of public interest”.
This strategy, common to many de-
veloping countries, has already been
adopted by other countries in Asia, such
as India and Thailand.
But these initiatives do not seem to be
over. For instance, during the last NPC
emerged crystal clear the intention of
the Government to reduce the benefits
that Pharma multinationals still enjoy:
even if patents have expired, in fact,
they still benefit from a premium price,
up to 10 times higher than the relevant
generic drug’s price. The NDRC, the
authority controlling, among others, the
price of drugs in China, announced a
series of price cuts especially meant to
squeeze margins of these drugs catego-
ries.
In a market increasingly imbalanced
towards generics, where the regulatory
mechanism aims at reducing even fur-
ther multinationals’ room, multination-
als themselves will have to struggle in
order to find new competitive strategies
to keep sustainable businesses in China.
Following, for instance, the example of
Pfizer and Merck, that have recently set
up joint ventures with local manufactur-
ers for the production of generic drugs.
At the same time, innovation will be
crucial going forward in order to keep
price superiority, in a context where
developing new molecules is becoming
tougher and tougher.
THE GENERICS EXPANSION
AND THE CHALLENGE OF THE
INNOVATION

14. Price cuts implementation results
Drug Price index (on retail price)*
Note: * includes all drugs in China.
Source: IMS, Credit Suisse Market Report, Value Partners analysis.
CAGR 2000-2011 (%)
2000 2001 2002 2003 2005 2006 2007 2008 2009 2010 20112004
-3,5%
140
129
123 122
115
109
105
101 101 101
99
94

15. PERSPECTIVE PHARMA MARKET IN CHINA
Price pressure in China is already con-
siderable and will even increase in the
future, not only because of the competi-
tion with generics, but also because of
continuous cuts imposed by the Govern-
ment. In this scenario, all the companies,
multinationals in particular, will have to
review their cost structure, as to guaran-
tee the sustainability of their business.
Since 2000 to date, three different price
cut rounds have been implemented by
the NDRC, involving more than 2.000
drugs and medical devices. The last
round, started in 2010, impacted several
therapeutic areas, from antibiotics
(March 2011) to contrast media products
(January 2013).
The general aim is to lower the “cost
to patient” of medical care; also in this
case, however, multinationals were af-
fected by the hardest cuts.
Once again, Government’s initiatives
are not over. At the very beginning of
2013 a new price cut, belonging to the
third wave, was announced. According
to the Government declarations it will
concern 20 drugs, such as breathing
remedies, and the cut entity will be 15%
on average, with peaks of 20% for more
expensive (branded) drugs.
Going forward, price pressure is des-
tined to increase even more. Recently,
a new mechanism for maximum retail
price setting has been announced and
discussed: retail price will not exceed
the ex-factory price of more than 25%.
The regulator has already required to
all the manufacturers to provide their
average ex-factory prices, in order to
start the evaluation of the impact of the
initiative and decide if, when and how it
will be implemented.
The impact of these maneuvers, espe-
cially for multinationals, will be huge; in
order to minimize the negative effect
of this latest price cut, the definition of
new strategies for distribution man-
agement will be crucial. As well as the
development of innovative solutions to
guarantee effective cost structures.
PRICE PRESSURE
Since 2000 to date, three
different price cut rounds
have been implemented
by the NDRC, involving more
than 2.000 drugs and medical
devices.

16. 16 – 17
However, price pressure is not only due
to Government cuts. For example, as
a trial, some hospitals in Beijing and
Shenzhen have already eliminated the
15% mark-up on drugs, that has histori-
cally represented hospitals’ main source
of funding. This initiative is only partially
counter-balanced by the increased
costs of medical visits. This represents
an important transition: drugs are in fact
moving from a profit center to a cost
center in the hospitals’ perspective.
This kind of initiative is already routine
in other Asian countries, such as Korea,
and could represent the pilot for a wider
intervention with the aim of making hos-
pitals’ P&Ls clearer and less dependent
on drug sales, that, according to NPC’s
March announcement, will be imple-
mented by 2015 in all Chinese hospitals.
Besides an increased price pressure,
this initiative, if implemented through-
out China, would significantly impact
the entire Pharma and HealthCare
business to hospitals. For instance,
hospitals are likely to reinforce or even
develop their own distributors in order
to compensate the lost profits, remark-
ably changing the value chain and its
dynamics.
Some hospitals in Beijing
and Shenzhen have already
eliminated the 15% mark-up
on drugs, that has historically
represented hospitals’ main
source of funding.

17. PERSPECTIVE PHARMA MARKET IN CHINA
Further initiatives in the regulatory
sphere will force Pharma companies to
re-shape their organization as to adapt
to the new context and, at the same
time, to review their model of presence.
In particular, attention to corruption
is becoming one of the Government’s
focal point. Over the last years, some
actions to reduce this plague have been
adopted: for example, a maximum limit
for “presents” to doctors and hospitals
chiefs has been introduced.
During the last NPC, the topic was
discussed again and indicated as a
short-term priority. In particular, refer-
ring to the bidding mechanism, that is
organized at provincial level in China.
According to the committee members,
it is urgent to change the system that,
organized in this way, “has resulted in
many bribes and corrupted activities”.
Therefore, commercial organizations will
have to review their business models,
stopping the old usual “entertainment”
to doctors and hospital managers in
favor of more transparent procedures.
Furthermore, the organizational struc-
tures and processes will need to be
reviewed, and the compliance to be
reinforced, as to face stricter Govern-
ment controls.
In a nutshell, for Pharma multinationals
China still represents the “place to be”,
in the very present as well as for future
development plans, even if context is
getting tighter both from a competitive
and regulatory perspective. However,
according to the latest reforms, only
those who will be able to anticipate the
Government measures and to timely
intervene will enjoy the growth poten-
tial of such an interesting market.
AN INCREASED ATTENTION
TO COMPLIANCE

18. DANIELA SCARAMUCCIA
Partner, Milan Office
daniela.scaramuccia@valuepartners.com
VALENTINA GORGOGLIONE
Associate, Milan Office
valentina.gorgoglione@valuepartners.com
MAURIZIO MINELLI
Associate, Hong Kong Office
maurizio.minelli@valuepartners.com
AUTHORS

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Management Consulting Limited
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