Quest for affordability driving innovation in China's pharma sector

16 May 2019

China's focus on keeping down the cost of public healthcare could turn it into a launchpad for the world's most innovative pharmaceutical products.

That's because bringing a new product to market or launching a new health-focused business is now often much easier and more cost-effective than it is in the West.

“It is now relatively easy and attractive for innovative startups to receive funding from venture capitalists or to attract shareholders via an IPO," says David Ng, Head of China Research at Macquarie Commodities and Global Markets.

“As a result, we're seeing a real influx of medical scientists returning from overseas where they were working for global pharmaceutical companies to launch their own pharmaceutical startup in China."

Reducing healthcare costs

In 2016, the central government enshrined its commitment to reducing healthcare costs in its Five Year plan. It then switched its focus from targeting the number of people covered by social health insurance (it was already 96.5% by 2015) to ensuring that those covered under this system had access to the latest, and potentially life-saving drugs.

To help achieve this, in 2017 the China Food and Drug Administration (CFDA) updated its National Reimbursement Drug List (NRDL) to include 300 new drugs.

In doing so, it asked pharmaceutical companies to tender for the opportunity to include their products on the list. This would give them the right to supply a drug to public hospitals in 11 of China's most prosperous cities, which together contain roughly one-third of the country's 1.4 billion citizens.

And, in choosing the winning bid for each category, the CFDA made price its main priority, Ng says.

“This has had the effect of bringing the average cost of 36 innovative drugs down 44 per cent. But the price of many drugs has come down by 60-70 per cent and in one extreme case by 90 per cent," Ng explains.

“However, because the selection process has been accompanied by tighter controls on quality, the process has come at the expense of drug companies' profit margins."

Not that this is necessarily bad news for pharmaceutical companies. Ng says that previously, making the NRDL was no guarantee of increased sales, as medical staff were still free to offer patients alternatives to the officially-endorsed drugs. That is no longer the case in the 11 trial cities.

“China's system of rebates made it profitable for medical staff to offer different drugs to those on the official list," Ng says. “Medical staff will no longer be able to do that, so sales will naturally increase even as their profit margins fall."

Making it easier to take a drug to market

Perhaps more importantly, CFDA complemented its change to the NRDL with reforms that make it significantly easier for drug companies to take a new product to market. This is especially true for any drugs targeting a rare disease or meeting a need not addressed by existing products.

These reforms include introducing a new fast track approval process and relaxing the need for China-based clinical trials.

“A lot less capital is now required to take a product to market in China, so drug companies incur much less risk when it comes to bringing a new product to market," Ng explains.

This is encouraging greater investment in early stage pharmaceutical businesses.

In fact, McKinsey research showed that in the first half of 2017, China's biotech companies attracted twice as much venture capital than in the corresponding period in 2016 (US$5.6 billion compared to $2.7 billion).

There were also approximately 30 IPOs in the 12 months to November 2017 with a combined value of US$2.8 billion.

McKinsey also noted there was an increase in the number of partnerships between Chinese and international companies in the medical and biotech space. However, Ng says that while the current regime should make such partnerships more lucrative to foreign companies looking to tap into China's market, there is a caveat.

A global impact on the pharma industry

Ng says that while it may be much quicker to start making a profit, this needs be tempered by the fact that if a drug proves successful the CFDA is likely to eventually also place it on the NRDL, thereby opening it up to competition and severely depleting profit margins.

“In this sense, the revenue from China's pharmaceutical market is almost the inverse of that in the United States or Europe," Ng says.

“Outside of China, bringing a product to market almost always involves a long period of uncertainty and millions of dollars worth of investment but once something is approved, the sky is the limit, so peak earning takes some time to get to."

“In China, it is relatively easy to take a new product to market and peak earning happens quite quickly before profit margins erode."

Ng concludes that this regime means we're likely to increasingly see companies use China as a market for launching innovative products before then taking them globally to capitalise on longer-term profits.