Big Pharma Faces its China Moment
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According to recent reports by McKinsey & Co., China will triple its annual expenditure on healthcare, which by 2020 will reach $1 trillion per year as the number of elderly people increases and the need for greater coverage is required. In 2011, nearly 123 million Chinese (9.1%) were over age 65. China’s government is planning to increase its health care budget to 7% of GDP from 5.5% in 2010. This change will make China the second biggest healthcare market in the world after the U.S., which spent 17.6% of its GDP on healthcare in 2009.
The Chinese healthcare market is still far behind other western countries in terms of development. This creates a vacuum that will have to be filled by a mix of domestic and foreign firms. The country is planning to spend most of its healthcare budget on drugs, hospitals and medical equipment. Last year, it spent nearly $116 billion on healthcare as it raised medical insurance coverage to 95% of the population. The Ministry of Human Resources and Social Security is aiming to cover all the rural and unemployed citizens in their insurance program by the end 2012.
Patent Expiration Driven
World’s leading drug manufacturers, such as Pfizer (NYSE: PFE) and GlaxoSmithKline (NYSE: GSK) are also expanding quickly in China. In the past year, several top selling drugs have lost patents whose sales will have to be made up. According to one estimate, the companies will witness a decrease of $350 billion in sales revenue from 2011 till 2015 due to the loss of patent protection.
Some companies, like Pfizer, decided to enter the competitive generic drug market after it lost control of its cholesterol drug Lipitor. Others, such as Bristol-Myers Squibb (NYSE: BMY) and Sanofi-Aventis have decided not to promote their massively successful drug, Plavix, after the drug's patent expired in May. The loss of a patent on a successful drug is a big deal. Pfizer’s profit dropped by 19% after it lost Lipitor. It had earned $5.3 billion in US Lipitor sales in 2010 whereas Bristol-Myers Squibb and Sanofi earned $6.1 billion from Plavix sales in 2010.
And this drug patent treadmill is something that the opening up of foreign markets will continue to eat away at. The potential for copying drugs, which after all are just chemicals, and re-selling them will only increase with increased demand for them outside of the West. Eventually, the cost of patent enforcement becomes too much to bear. U.S. pharmaceutical multi-nationals better begin cozying up to China’s government if they want to continue to fund their research on the backs of their customers. And it looks like they are.
China’s prescription drug market will become the second largest in the next eight years if it continues to grow at the current rate. In 2010, the market’s net worth crossed $50 billion and more than doubled in 2011 to $110 billion and the Chinese government is pushing this growth with generous tax exemptions and credits.
Sick Globally, Treat Locally
And there is no better way to gain favor in China than to bring higher-end jobs and R&D there. Pfizer has made it clear that they intend to do that on top of some recent moves. Last year, Pfizer announced that it was partnering with Shanghai Pharmaceuticals to increase the sales of Prevenar vaccines in the rural areas of China. This was followed by another agreement with Zhejiang Hisun Pharmaceutical to manufacture and sell generic drugs for both the Chinese and non-Chinese markets.
Pfizer’s agreement with Hisun will also be a win-win situation for both firms because Hisun is one of the leading manufacturers of a primary drug component – Active Pharmaceutical Ingredients -- while Hisun will benefit in terms of R&D, operational knowledge and international exposure by working with one of the biggest multinational pharmaceutical companies
Pfizer’s rival, Novartis (NYSE: NVS), is planning to dominate the Chinese vaccine market. Last year, it acquired 85% stake in Zhejiang Tianyuan Bio-Pharmaceutical, a local vaccine company. Novartis is also looking to expand its R&D, manufacturing and sales base in all the emerging markets, particularly in BRIC countries. In China alone, it has set an R&D investment budget of $1 billion for the next five years. In the H1 2012, Novartis earned 24% of its net sales from emerging markets.
Likewise, GlaxoSimthKline (GSK), which already has a 4,000 strong sales force in China, is planning to expand further. Like its peers, it is also developing more R&D facilities in the country. Also, like its peers it is doing so by shifting resources out of the West and into China. GSK is now developing a research centre specifically for traditional Chinese medicine (TCM). Their unique and innovative strategy is to combine the modern drug knowledge and technology with TCM’s therapeutic experienced-based products to manufacture drugs for Chinese and international markets, appealing to local tastes and traditions.
Bowing to Tradition
It would seem that GSK is taking the erosion of the patent protected business model to heart. One of the criticisms of the medical industry in the U.S. is how the structure favors the drug companies at the expense of non-patented or protected competition. Now that the system in the U.S. has bankrupted the country in the present and the future, Big Pharma may have to dial down their rent-seeking activity and sell products based on their branding, like Bayer does with aspirin.
The problem is that the drug companies don’t want to sell commodities, but like cable operators, commodities are what they sell. They have been the most vocal opponents of traditional and homeopathic remedies for decades as they are the competition just like meat and eggs are competitors to government-subsidized corn and soybeans, which ironically make you sick so then your doctor prescribes you Lipitor.
And that’s the new quandary for them. So far the Chinese have not seen a massive spike in lifestyle diseases like Type 2 diabetes and various auto-immune disorders, but it will come with the successive generation grown up within a culture of poorer food choices. This first generation of aging Chinese will not alter their food habits enough to create the same health problems experienced in the West over the dominant low-fat, high carbohydrate diet inspired by adherence to the lipid hypothesis.
Right now, they are now caught between expiring patents and patentable opportunities and becoming vassals to the Chinese government that will dictate pricing policy in its favor. The opportunity, however, is there to sell in volume lower-margin drugs and therapies as the gray market for their traditional rent-seeking drugs will push margins lower. The best path is to abandon that model and embrace the fact that intellectual property protection is a losing business model in the long term.
PeterPham8 has no positions in the stocks mentioned above. The Motley Fool owns shares of GlaxoSmithKline. Motley Fool newsletter services recommend GlaxoSmithKline. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.