1. C
hina’s healthcare sector is
facing a radical shake-up as
the government takes on the
central problems of hospital funding
and drug pricing. Reforms taking ef-
fect this year could iron out some of
the distortions that lead to over-pre-
scription of medicines, as well as
allow market forces to take a greater
role in how those pharmaceuticals
are priced. The result should be a
more efficient healthcare sector, but
the impact on foreign companies,
especially pharmaceutical compa-
nies, is far from clear.
Even though government spend-
ing on healthcare has been rising,
it is still relatively low compared
with other countries and hospitals
are largely left to their own devices
to raise money. As of 2014, govern-
ment spending on healthcare was
only 5 to 6 percent of GDP, well
below the 9.3 percent average among
countries in the Organization for
Economic Cooperation and Devel-
opment. Some of this money goes
to hospitals, but direct government
subsidies constitute just 10 percent
of their revenue, with much of the
remainder coming from profits on
the sales of pharmaceuticals. Bain
& Company estimates that drug
profits make up 40 to 80 percent of
their revenue, which comes from a
15 percent markup they have been
allowed to charge.
As the markup is mostly fixed,
hospitals can increase revenue
mainly by raising the volume of
drugs sold. Because of a lack of fund-
ing, hospitals have been dependent
on pharmaceuticals to boost reve-
nues. In many hospitals, doctors get
bonuses for prescribing drugs. The
result is far too many pharmaceuti-
cals are prescribed, increasing costs
for patients. There is also a medical
risk for patients taking medicine they
don’t need, as well as the increased
speed with which diseases develop
resistance to antibiotics.
The lack of funding also means
hospitals struggle to pay doctors what
they are worth. According to Chi-
nesemedicalnews.com, the average
doctor in a large, tier-one city hospi-
tal (not including bonuses) officially
earns RMB 46,000 per year ($7,500).
In reality, doctors’ incomes are often
much higher, supplemented by:
1) Commissions - from prescribing
pharmaceuticals and ordering
tests (legal)
2) Moonlighting - providing ser-
vices at facilities other than their
primary hospital (sometimes
legal)
3) Hongbao - red envelopes filled
with money from patients hop-
ing for better service (illegal)
With both hospitals and the doc-
tors working in them seemingly on
the make, trust in them among the
Strong Medicine
By Tyler Hervey
China strives to make medicine prices more palatable
REFORM REPORT
RMB
46,000
Average official
income for a
doctor in a tier-
one hospital.
Doctors
supplement
this low salary
with hongbao,
moonlighting
and
commissions
from drug
prescriptions
and tests.
Source:
Chinese
medicalnews.com
public is waning, as demonstrated
by the increase in violence against
medical staff. A survey by the China
Hospital Management Association
found that violence against medical
personnel rose an average of 23
percent each year between 2002 and
2012.
This runs directly counter to
Chinese Communist Party goals of
reducing out-of-pocket costs, which
according to the People’s Daily are
to be below 30 percent by 2017.
“Changing hospitals’ income
structure by making them less
dependent on pharmaceutical sales
has always been an emphasis of
healthcare reform, but it’s also one
of the major challenges too,” said
Zhou Jun, Director of the AmCham
US-China Healthcare Cooperation
Program. “The solution has to come
from within, meaning the hospitals
need to have strong motivations to
make that change.”
Farewell to
pharmaceutical
profits
The government is responding to
this unhealthy trend. On May 9,
the State Council said that “pub-
lic hospitals should be operated
for the public good, instead of
seeking lucrative gains,” and an-
nounced a ban on for-profit sales
Business Now Magazine14
FOCUS

2. of pharmaceuticals in all of the
country’s 6,800 hospitals by 2017.
The reforms, which have already
been implemented in 17 cities, will
expand to 100 cities this year. Ac-
cording to the South China Morning
Post, hospitals in prefecture-level
or above cities will no longer be
able to supplement their income
by selling pharmaceuticals and will
instead rely on funding from local
authorities and increased charges
for medical services to cover their
costs. This change will be accompa-
nied by updates in the performance
assessment system for hospital staff,
encouraging hospitals to be more
focused on quality service instead of
pharmaceutical sales.
But skeptics remain concerned
about exactly how the Chinese gov-
ernment is going to account for the
massive loss of revenue facing public
hospitals. Although hospitals are
now allowed to mark up prices on
services and will receive increased
funding from government, it’s still
unclear whether these two sources
of funding alone will suffice.
Even so, recent reports state
that hospitals which have already
implemented the pilot program
have faced no big revenue losses.
“Hospitals’ profits from medicine
sales have been affected but the loss
is compensated by higher charges
for medical service and funding
from local government,” Sun
Zhigang, Deputy Director of the
National Health and Family Plan-
ning Commission, was quoted by
the Global Times as saying.
The end of price
caps
As well as reforming hospital funding,
the government has also been try-
ing to reform the pricing system for
pharmaceuticals in an effort to lower
overall costs. June 1 saw the begin-
ning of a program to lift maximum
retail prices, whereby the government
set prices for more than 2,700 types
of drugs, comprising 23 percent of
China’s drug market. This system was
vulnerable to manipulation, as many
manufacturers inflated their costs of
production, which were ultimately
passed on to both the government
and the consumer. Furthermore,
because of low price caps, many com-
panies refused to produce with low
profit margins, thus creating shortages
of vital products.
For foreign drug makers, the
reforms could mean an end to the
unusual situation in China where
their profits from patented phar-
maceuticals constitute only a small
portion of their overall profits. Most
of their profit comes from origi-
nal pharmaceuticals with expired
patents, which could command a
premium in the original system
because of the relative poor quality
of locally produced generics. Lifting
the controls means the focus will
return to price and MNCs won’t be
able to take advantage of the guaran-
teed higher price for their products.
Many questions remain about
what impact greater market in-
fluence will have on hospitals’
purchasing patterns. “The previous
procurement system took account
of the higher quality of original
drugs,” Zhou said. “The price of
original drugs wasn’t expected to be
the same as generic drugs because
the quality of the original product is
better. I hope that the new mecha-
nism continues to take quality into
account and not only price.”
MNCs are likely to see a price
reduction on their patented drugs as
well. At a May 22 press conference,
Sun of the National Health and
Family Planning Commission told
reporters, “The prices at which we
now buy patented drugs and unique
drugs are falsely high.” The new sys-
tem will determine prices through a
“transparent multiparty system” that
will include parties such as hospi-
tals, provincial governments and
possibly others. Further details are
expected this month.
Getting these reforms over the
line will be challenging, but a great
deal is at stake. McKinsey forecasts
that healthcare spending in China will
accelerate to $1 trillion in 2020 from
an estimated $511 billion in 2013, and
foreign companies will be looking to
see how their product offerings fit into
China’s long-term plans.
Tyler Hervey is an intern with the
US-China Healthcare Cooperation
Program.
“The solution has to come from within,
meaning the hospitals need to have strong
motivations to make that change,” said
Zhou Jun, Director of the AmCham US-
China Healthcare Cooperation Program.
Reshuffling the medicine cabinet
Share of Chinese pharmaceutial sales
Patented Branded off-patent Generic
Source: Bain & Company
2012 2019-21* 2021-24*
100
80
60
40
20
0
September 2015 15
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