China - Pharma faces China healthcare challenge

SAN FRANCISCO - Milling around the hotel lobby at the Sir Francis Drake hotel in downtown San Francisco are an eclectic group of investors, entrepreneurs and executives from established healthcare companies.

They have all come to learn more about China's healthcare market; how better to invest in, raise capital from, and sell into the country's exploding biotech, life-sciences, pharma and medical device sectors. Hosted by OneMedPlace, a New York-based research organization, Monday's China Forum shed new light on the rapidly changing healthcare landscape in China.

As Chinese society has advanced over the past two decades, some of the most compelling business opportunities have been those that address the most overwhelming needs of the country's people. No opportunity reflects this better than healthcare. Equally, no market space may better capture the unique challenges to successfully operating in China given the role of the Chinese government as the funder, organizer and distributor of healthcare services and its nascent efforts to build a higher quality healthcare system for its people.

Western companies are eager to tap into the growing Chinese healthcare market; yet, the challenges many of them face are more complex than has been appreciated until recently. The challenges range from the traditional (regulatory, protection of intellectual property) to the unusual (prompting Chinese to save less because they are confident in public healthcare).

In the late 1980s and early 1990s, China was a poor country in need of jobs. While job creation still remains a top priority for Beijing, now the central government faces a twin challenge: making sure job creation continues and that social services are expanded.

Not only must China expand social services, it must ensure that distribution of, and access to these services is perceived as fair and equitable across its provinces. Already, signs are growing that rural Chinese are growing increasingly frustrated over the lack of services they have access to in relation to their urban counterparts.

Jonathan Woetzel, director of McKinsey's Greater China Office, has written "The dismantling of state-owned enterprises and rural collectives has left hundreds of millions of people in China's impoverished countryside to fend for themselves when it comes to health care, old-age pensions, and education."

Woetzel notes, "Recognizing that such inequalities heighten the potential for social unrest, the government recently stepped up its efforts to address the needs of the rural poor."

China has made significant progress in extending healthcare services to all Chinese, James Huang, managing director for Kleiner Perkins Caufield & Byers noted at the forum. According to Huang, since 2009 "basic healthcare insurance now covers 1.295 billion people; and, this was all done in three years".

The quality of this insurance and the healthcare it provides remain areas for marked improvement, but as Huang put this step in the right direction - "It was all done in three years. Can you imagine something like that being done in the United States in a similar time frame?"

This amazing progress has been made possible because of three factors: first, the Chinese government's pursuit of improved healthcare as part of its Five-Year Economic Plan; second, the government's increased willingness to allow privatization of certain healthcare services; and third, aggressive price controls put in place for government owned and operated hospitals, focused on the cost of government-covered pharmaceuticals in particular.

China's 12th Five-Year Plan expands on what the government hopes to accomplish in these areas. Typically seen through the prism of China's economic development strategy and the strategic emerging industries the country announces it will be pursuing, the most recent plan also shows Beijing's awareness that it must expand the social safety net in order to get Chinese to stop saving and start spending - a critical transition if the Chinese middle class is to continue expanding.

Three economists, Marcos Chamon from the International Monetary Fund, Kai Lui from John Hopkins and Eswar Prasad at the Brookings Institution found that, thus far at least, the Chinese government is not having much success on this front. In fact, as they write, "Chinese households save a large share of their disposable incomes and their average saving rate has increased over the last decade and a half."

What may surprise some is their finding that "This pattern is particularly pronounced for urban households." Young Chinese, in what they call an act of "self-insurance", continue to build their savings for two things: unforeseen medical expenses and the high cost of housing.

In order for the Chinese government to convince both its young urban and aging rural populations that they can save less, it must ensure that higher quality and more efficient healthcare is available. With this in mind, the government has put into place increasingly aggressive cost savings' plans to try and control expenses. First among these endeavors has been the National Development Reform Commission's (NDRC) two rounds of mandatory price decreases on key drugs - primarily antibiotics and cardiovascular - over the past year.

For pharmaceutical multinationals that are deriving more and more of their top-line revenue and bottom-line profits from the China market, the NDRC's moves are troubling. According to Huang, from the point of view of the Chinese government, these are necessary steps to take but they are putting pressure on companies eager to sell into the Chinese healthcare market.

Huang said that while "the Chinese government announced it would be putting US$125 billion into healthcare in 2012, that means the budget is only going up 1%, while consumption is going up over 15%."

Enabling this process of expanding coverage by compressing prices has been the success of what analysts call the "Anhui Model". Originally designed for eastern Anhui province in 2010, the centralized tender process had been expanded by December 2011 to 16 provinces across China.

The trade pharmaceutical and medical supply companies are asked to produce in volume for significantly decreased price, the only exchange the central government can really offer given its need to expand services and keep costs under strict controls. What concerns industry analysts like Huang is that this model is proving to be successful for the provincial governments, which means it could be deployed more broadly in the Chinese healthcare market to cover diagnostics and medical devices as well.

In a market where some estimates of out-of-pocket expenditures on basic healthcare services exceed 50% for the average person in China, newer medical procedures for common health problems like cancer, diabetes and cardiovascular issues, are out of reach.

As was noted in Monday's OneMedPlace China Forum, the Chinese are aware that heart stents are priced to the consumer at eight to 10 times ex-factory pricing, which begs the question for both Beijing's central government and the typical Chinese healthcare consumer of how much they are willing to pay for such a procedure.

In the West, this is largely a moot question given public and private insurance provides largely satisfactory coverage; however, in China the cost may mean certain life-saving practices taken for granted as rudimentary in the West are avoided in China. One analyst noted on Monday that diagnosis and mortality rates for cancer are very tightly linked in China. Essentially, when a Chinese person is diagnosed with cancer, they soon will die from it. Why? Diagnostics, while new in China, are reasonably cost effective while the subsequent medical procedures are out of reach due to cost.

Beijing's efforts in the healthcare market have certainly not all been bad for Western multinationals. Huang noted on Monday that some "60% of China's healthcare stimulus money ended up going to non-Chinese multinationals". While the headwinds of expanding government-sponsored coverage for basic medical services and drugs remain a challenge, a recent JPMorgan report noted that AstraZeneca, Sanofi, Roche, GlaxoSmithKline, Novo Nordisk, Johnson & Johnson and Pfizer all realized over 30% growth from their China operations in the early part of 2011.

Beijing deserves credit not only for recognizing the pressing need to expand basic healthcare services across both its rural and urban populations, but also for its attempt to walk the fine line between more centrally driven Anhui-style reforms and tentative efforts towards hospital privatization, allowing the country's best doctors to work one day a week at a private hospital, and the expansion of private insurance.

China's ability to deliver expanded healthcare coverage may rank second only to the country's ability to deliver economic growth in terms of keeping the country stable and unified. For Beijing, its policies in this area must be more nuanced and sophisticated than perhaps any other industrial or political issue.

It must aggressively push for cost reductions given its limited wealth and seemingly unlimited number of healthcare needs. It must also develop domestic capabilities to research new, and produce existing drugs and devices for the healthcare needs of its people, two steps that will require Western technology. And, it must do all of this while reforming its insurance in such a way as to continue promoting consumption from a reluctant Chinese populace.

These overwhelming needs and the compelling opportunities they suggest may be the most interesting and compelling since the country's last round of major economic reforms in the late 1980s.

Benjamin A Shobert

Asia Times

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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