New Healthcare Reform in a New Era Challenges for Multinational Pharmaceutical Companies and Corresponding Countermeasures to Be Taken February 2018

New Healthcare Reform in a New Era Challenges for Multinational Pharmaceutical Companies and Corresponding Countermeasures to be Taken February 2018

跨国药企的挑战与应对

Growth of MPCs’ sales in China has slowed down 4

Brand-Name Drugs have lost the advantage of high premium 6

“Trade price for market” negotiations have failed to 7 achieve desired results

Looming trend towards replacement of imported drugs 9 with home-made drugs

Operating pressure pushes pharmaceutical companies to 10 adjust their business arrangements

A strategic transition has become essential 12

Conclusion 18

02 New Healthcare Reform in a New Era

Introduction

The pharmaceutical industry, is considered by China's 13th Five Year Plan as a pillar industry that will fuel economic growth in the future, and is expected to maintain medium to high growth rates due to the increasing medical demand. At the same time, with a slower growing domestic economy and deep reforms into China's social protection system, Beijing has been focused on medical cost control through a policy mix that includes tendering and medical insurance, encouraging the usage of cheaper domestically- produced drugs over higher priced imported ones. As a result, multinational pharmaceutical companies (MPCs) will face a more challenging environment going forward, as described in greater detail hereafter.

3 New Healthcare Reform in a New Era

Growth of MPCs’ sales in China has slowed down

MPCs have experienced a less robust more than 100 beds) grew at the rate only three MPCs performed better sales growth in China. According to of 8.5% in 2016, while the growth than the average growth rate of data from QuintilesIMS, the total sales rates in 2012 and 2013 were 11.5% all the domestic and multinational volume of MPCs from hospitals (with and 12.2% respectively. Furthermore, companies (8.1%) in 2016.

Pharmaceutical sales in Chinese hospital market and top 20 players in 2016

(RMB, billion) (%) Average = 8.1% 600 16 Pfizer RMB 17.2 bn 530 Yangtze River 14.0 491 14 AstraZeneca 500 467 12.2 Qilu 419 12 SihuanPharm 400 11.5 10 Fosun Group 11.5 8.5 Heng Rui 300 8.0 8 Sanofi 5.1 Kelun 6 200 167 Chiatai Tianqing 132 148 154 4.5 4 Bayer 100 Shanghai Pharma 2 Novartis MPC 0 0 Roche Domestic company 2013 2014 2015 2016 SinoPharm Growth in 2016 Merck Sales of domestic company CSPC Sales of MPC Buchang Pharma Novo Nordisk Sales growth of domestic company (right axis) Reyoung RMB 6 bn Sales growth of MPC (right axis)

Source: QuintilesIMS, Deloitte Research

The decreasing growth rate of of GDP, with a growth rate exceeding adopting a series of policies to control MPCs’ sales is closely related to the one of the economy. The rapidly drug prices, reducing hospitals' China’s healthcare reform focused rising health expenditure has put reliance on drug sales as well as on cost control. Currently, China’s pressure on the healthcare insurance imposing more rigorous compliance basic healthcare insurance system fund, resulting in a policy focus of the requirements on the entire healthcare covers more than 95% of the total current healthcare reform on cost industry. population. Furthermore, China’s control. The priority measures taken health expenditure represents 5.9% by the Chinese government include:

4 New Healthcare Reform in a New Era

5 New Healthcare Reform in a New Era

Rapidly rising health expenditure has put pressure on healthcare insurance fund

The growth rate of health expenditure Increasing income and expenditure of has exceeded the one of GDP basic healthcare insurance fund in urban areas

（%）（%）（%）（%） 40.00 40.00 30.00 30.00 35.00 35.00 25.00 25.00 30.00 30.00

20.00 20.00 25.00 25.00

20.00 20.00 15.00 15.00 15.00 15.00 10.00 10.00 10.00 10.00

5.00 5.00 5.00 5.00

0.00 0.00 0.00 0.00 2006 20072006200820072009200820102009201120102012201120132012201420132015201420162015 2016

Health HealthExpenditure Expenditure Growth Growth Rate RateGDP GrowthGDP Growth Rate Rate IncomeIncomeExpenditureExpenditure

Data: National Bureau of Statistics, National Health and Family Planning Commission, Deloitte Analysis

Brand-Name Drugs have lost the advantage of high premium

MPCs’ profits are mainly generated by a negotiated price was too low, that have passed the evaluation can their brand-name drugs (i.e. imported pharmaceutical companies would theoretically take part in the bidding drugs whose patent protection periods in be forced to abandon the bidding in process alongside brand-name drugs, many cases have actually expired), which order to secure their bids in other resulting in further downside pressure are being sold at premium prices. The provinces. In 2015, during Hunan’s on brand-name drugs’ profit margins. Chinese government introduced several measures, trying to reduce drug prices centralized procurement for drugs, and resulting in downward pressure on the overall bid price dropped Over the past ten years, brand- brand-name drugs’ profit margins. significantly, achieving a maximum name drugs experienced rapid price reduction of 50% after two growth, partly owing to a favorable In the second half of 2015, increased bidding rounds and consequently government policy. However, pressure on the “price ceiling” at the forcing Bayer, AstraZeneca and other decreasing drug prices and strict bidding stage, forced most MPCs to MPCs to abandon their bids. regulations will make it difficult for substantially lower their prices. At the brand-name drugs to maintain the same time, since most provincial biddings Moreover, the government has high premium – requiring a change referred to the national minimum- launched an evaluation of generic of MPCs’ traditional, brand oriented winning bid, companies hesitated drugs’ consistency. Generic drugs business model. to adopt low-price strategies. If

6 New Healthcare Reform in a New Era

“Trade price for market” negotiations have failed to achieve desired results

In addition to a centralized However, during the implementation negotiations, it is up to the Ministry of procurement process, the process, achieving a “trade price for Human Resources and Social Security government has organized national market” turned out to be easier said to decide if the drugs can be included price negotiations with regard to than done. As of December 23, 2016, in the healthcare insurance system. certain brand-name drugs. In May only 23 provinces had included the Furthermore, the fundraising capacity 2016, the National Health and Family negotiated drugs in the coverage of varies from province to province. Planning Commission announced the the healthcare insurance system. However, for MPCs to accept a results of the first series of national Different management structures considerable cut in their profit margin, drug price negotiations, resulting into over the healthcare insurance system an inclusion of their negotiated drugs prices reduction for products such make it difficult to achieve agreement in the healthcare insurance system as Tenofovir Disoproxil, Ekotinib and over drug price negotiations is key, allowing an increase in sales Gefitinib (see graph) and health insurance. While the that can potentially compensate the National Health and Family Planning effects of the price reduction. Commission leads the drug price

Results of National Drug Price Negotiations in 2015

RMB

6000

5000

4000 55% 3000 54% 2000

1000 67%

0 Tenofovir Disoproxil Ekotinib Gefitinib (GlaxoSmithKline) (Betta Pharmaceuticals) (AstraZeneca)

Before Negotiation After Negotiation

Data: National Health and Family Planning Commission, Deloitte Analysis

7 New Healthcare Reform in a New Era

8 New Healthcare Reform in a New Era

On the other hand, the scope of the implemented reform of the payment method, i.e. payment according to DRGs (Diagnosis Related Groups), is expanding. The payment according to DRGs, as a method of payment in advance, is more efficient in controlling healthcare insurance costs –compared to the original Looming trend method of payment in arrears, such as payment according to projects. This new payment method will effectively towards replacement restrain hospitals from prescribing more expensive medicine, thus encouraging medical institutions to of imported drugs use domestic products with similar curative effects but lower prices. with home-made All these abovementioned measures are likely to restrict hospitals’ use of expensive brand-name drugs and drugs drive doctors to domestic generic drugs that are more cost-effective. However, price considerations Against the background of stricter are not the only matter related to cost controls, many regions are generic drugs, since assuring drug encouraging the use of less expensive quality is crucial. Therefore, the domestically produced generic drugs Chinese government is taking multi- over imported brand-name and pronged approaches to enhance generic drugs. the competitiveness of domestic pharmaceutical companies as well as Furthermore, two major measures to improve the quality of domestically were implemented to reduce hospital produced generic drugs by adopting prescriptions of expensive brand- consistency evaluation and a new name medicine, which had resulted edition of GMP (Good Manufacturing from a malfunctioning incentive Practice). Thus, the quality difference mechanism for medical institutions. In between products of domestic May 2015, the Government published pharmaceutical companies and those the “Guiding Opinions on Urban Public of MPCs will gradually be reduced. Hospital Comprehensive Reform Pilot”, with the aim to lower the percentage of medicine sales in revenues of pilot public city-level hospitals to around 30% by 2017. This measure will have a significant impact on sales of imported drugs that are sold at premium prices.

9 New Healthcare Reform in a New Era

Operating pressure pushes pharmaceutical companies to adjust their business arrangements

The main focus of the healthcare has also declined. Due to the high Bristol-Myers Squibb – under its reform is price reduction. Therefore, cost structure of MPCs, keeping all mature product life cycle management MPCs are facing a challenging low-profit projects is not suitable strategy – has successively divested environment, potentially slowing down anymore. One of the responses to its diabetes, tumor and cardiovascular future growth. As a result of a series the government policies, a few MPCs departments, using a cost control of government policies, including have started to review their current approach to increase its profits. strict regulation of drug prices and product portfolio, reinforcing and Furthermore, Bristol-Myers Squibb cancellation of drug mark-up policy, strengthening competitive products has shifted its focus to biological and MPCs’ drug prices have significantly while selling or reducing weaker innovative medicines. decreased and their market share internal product lines. For instance,

Bristol-Myers Squibb adjusted its business layout in 2016

Laid off both Taxol and Paraplatin product groups within tumour department

Aug. Mar. Aug. Abandoned diabetes market, Abandoned cardiovascular transferred Glucophage to department product co-promoter Merck

Feb. Dec. Transferred the HIV drug Laid off the entire OTC business R&D line to ViiV Healthcare in China, ceased all marketing for OTC products

Focusing on biological and innovative medicines

Data: Public Information, Deloitte Analysis

10 New Healthcare Reform in a New Era

Overview of MPCs’ transfers Under this context, many of business to domestic pharmaceutical companies have pharmaceutical companies in 2016 begun to readjust their marketing Such strategic resetting of product strategy. Steering away from their portfolios, and allocation of internal past relationship marketing, MPCs resources, is demonstrated through introduce the functioning, use certain transfers or collaboration and effects of their drugs during models with domestic companies professional academic forums and initiated by MPCs in 2016. seminars and conduct interactive information exchange with doctors Finally compliance focus, increased via digital platforms. These by stronger regulation has also marketing methods do not only put pressure on MPCs same as help to strengthen compliance, but their domestic counterparts. More can also reduce costs. Moreover, recent marketing compliance issues, pharmaceutical companies have such as those reported by a CCTV implemented a series of compliance report on Chinese doctors receiving measures on drugs marketing, kickbacks, broadcasted in December such as: reducing sales expenses, 2016 – have led to tighter regulation. optimizing marketing-related systems Thus, compliance and business risk and procedures for reimbursement management in the healthcare sector and conferences, and adopting more will remain a major focus. precise cost control methods in order to lower catering, transportation and administrative costs.

Multinational Domestic Date Pharmaceutical Transferring Business Pharmaceutical Companies Companies

Commercial operating rights of White&Black, Canesten, January 2016 Mycospor, Redoxon and Saridon in China

Right to sell Plendil in China, global asset (besides US) of March 2016 Imdur

May 2016 Injections and sprays of Miacalcic

Full ownership of Nanjing MeiRui Pharma, including the July 2016 manufacturing site at Nanjing and its urology products

October 2016 Commercial license of Byetta and Bydureon in China

Rights to sell Ceclor and Vancocin November 2016

Data: Public Information, Deloitte Analysis

11 New Healthcare Reform in a New Era

A strategic transition has become essential

The new round of healthcare reform Conducting localized production is a multi-dimensional reform. and R&D MPCs that hold on to their past China’s pharmaceutical market, development model will inevitably maintaining double-digit growth rates suffer a decelerated future growth. is obviously considered very attractive To counter this scenario, a readjusted among MPCs. Moreover, MPCs’ future suitable marketing strategy is crucial. growth goes hand in hand with their business arrangements in China. In How can MPCs succeed under the order to reduce production costs, new circumstances in China? better serve China’s market demand, and reduce the time to market for new medicines, MPCs are considering Production and R&D: Localization more often to switch from an import- oriented to a local-oriented business model.

A strategic Localizing brand-name drugs transition becoming production brings further advantages, a must such as an increased reaction time to local markets, the possibility to

Market Business Model: win over favorable bidding policies, Arrangement: Build overall and the opportunity to develop and Shift towards solutions, grassroots level “Internet+”, expand local markets. cooperation with insurance companies Then, quite a few MPCs have also Data: Deloitte Analysis established wide ranging and sophisticated research centers in China, such as Novo Nordisk, Roche, Pfizer, Johnson & Johnson, AstraZeneca, and GlaxoSmithKline.

12 New Healthcare Reform in a New Era

MPCs increased investments in local R&D in 2016

Investment Date MPCs Investment in R&D Amount

Announced it will form a new public health institute in Beijing - Help Over 20million GBP March 2016 China tackle the health threats posed by antibiotic resistance and (plan) infectious diseases.

Establish development and launch facility and the China Commercial Innovation Center (CCIC) in Wuxi - Support the April 2016 development and manufacture of innovative small molecules, the 50million USD CCIC is expected to attract more cross-border partners to carry out the AstraZeneca’s 3-D strategy (Diagnostics, Device and Digital)

The Biomedical Research & Development center in Shanghai became fully operational – New medicine research focuses on June 2016 1billion USD diseases with high incidence rate in China and Asian region, including cancer and liver diseases

Will establish a Global Biotechnology Center in Hangzhou – June 2016 Localized Biopharmaceutical base integrating development and 0.35billion USD manufacture, with focus on cancer-related biological medicines

Data: Public Information, fDi Markets, Deloitte Analysis

As the Chinese government clinical trials and making new drug published by the Chinese government continuously publishes new price applications. As China’s market grows in February 2016, applications for reduction policies, MPCs may lower rapidly, this situation is changing. innovative drugs that have not been costs by localizing production. Also conducting R&D in China helps sold in or out of China or whose While China is losing its cheap labor accelerating the launch process of production has been moved to China advantage, in many industrial parks, new drugs in China and at the same can be examined and approved as local governments have launched time extends the earning cycle of a priorities. Thus, conducting R&D in policies to attract investments, drug. So far, China’s contribution of China helps accelerating the launch including preferential taxes, rent, new drug launches has been relatively process of new drugs in China and at financing, etc. low, compared to other countries, the same time extends the earning see figure below. According to China’s cycle of a drug. Furthermore, due to differences existing drug approval regulations, of ethnicity and disease spectrum, for a foreign new drug to be licensed developing new drugs specifically in China, clinical trials need to be for the Chinese market becomes re-conducted, which takes at least 3 increasingly crucial. In the past, to 5 years, deferring the treatment research centers in China were of patience over a long period of restricted solely to assisting tasks for time. However, according to the research centers abroad, conducting reform of the drug approval process

13 New Healthcare Reform in a New Era

Proportion of global innovative drugs’ first launched markets (2007-2015)

56.3%

12.6%

7.7% 6.5%

3.1% 2.5% 1.8% 1.5% 0.9% 0.9% 0.3% 0.0%

Innovative U.S. Japan UK Germany Switzerland South... China Canada France Denmark India Israel contribution tiers1 1 2 3

Note:1. Measured by the number of pipeline molecules and the number of new drug launches

Data: Chinese Pharmaceutical Enterprises Association and other entities, "Fostering a Sustainable Ecosystem for Drug Innovation in China"; only considering the listed countries, totaling 100; only counting new molecular entities.

Some MPCs, rather than establishing Medicine market arrangement at Under this context, MPCs may own local research centers, are the grassroots level consider arranging their business making use of local talents by In recent years, government’s towards the grassroots, including cooperating with local pharmaceutical support and investment led to county-level hospitals, community companies. For instance, innovative abundant opportunities in county- health service centers and retails. and research-driven local companies and community-level hospitals and So far, quite a few pharmaceutical may take over MPCs' early-stage other grassroots markets. According companies have already made their projects and conduct further localized to data from QuintilesIMS, the moves. In 2011, Sanofi took the lead development, tailored to the needs of grassroots pharmaceutical market and established the Primary Care Chinese patients. has great development potential, as Business Unit to reach out to China’s the drug sales in community hospitals county-level markets. Its product There was a wave of Sino-foreign joint will rise rapidly at the rate of 18%, arrangement included diabetes, ventures in 2012, e.g. Merch joined with a growth rate higher than at cardiovascular, central nervous force with Simcere Pharmaceutical, 2nd and 3rd -class hospitals. With system and tumor products, – thus, and Pfizer teamed up with Hisun the implementation of hierarchical products with a strong demand Pharmaceutical. However, it seems diagnosis and treatment, the in grassroots markets. Moreover, that this round of joint ventures has integration of new rural cooperative Sanofi’s grassroots market coverage ended in failure, showing that – after medical systems with urban resident is part of its annual strategic priority a trial for more than three decades basic health insurances, and stricter in 2016, and it is planning to expand – the business model of establishing cost control policies implemented more community medical centers joint ventures still needs further by major hospitals, a move of the and retail pharmacy businesses. exploration and adjustments. medicine market towards the Furthermore, in order to expand grassroots level is inevitable. market channels, companies like Merck and Pfizer have also increased their investment in retail pharmacy.

14 New Healthcare Reform in a New Era

However, it is worth noting that due to whose medicine structure primarily regional and demographic factors, the focuses on essential medicines, dominate county-level markets face a low ratio of the grassroots markets, opportunities also market investment to medicine sales exist for MPCs, adopting new strategies volume – an issue that MPCs need to face the high-volume but low-margin to overcome. Moreover, since mainly bottom markets. domestic pharmaceutical companies,

China's pharmaceutical sales by terminal

(RMB, million) (%)

900,000 20 18 800,000 18

700,000 16 14 14 600,000 12 12 500,000 11 9 10 400,000 7 8 8 8 300,000 6 200,000 4 100,000 2 0 0 2nd and 3rd-class hospital Drug store Community hospital Others

2012 2014 2018e CAGR 2012-2014 (right axis) CAGR 2014-2018 (right axis)

Data: QuintilesIMS, Deloitte Research

15 New Healthcare Reform in a New Era

In this regard, MPCs need to have Exploring new business models “Internet+”, allowing a chronic disease an overall understanding of the and overall solutions management, made cooperation particularity of each market, when With patients focusing strictly on between MPCs and mobile medical choosing their targets. They may curative effects of the drugs, MPCs companies essential. For instance, prioritize grassroots markets with may explore new business models, pharmaceutical companies like Sanofi, a more advanced economy, higher providing overall health solutions for AstraZeneca, Merck and Bayer have population density, and better patients. Such new business model all decided to cooperate with mobile development potentials. Moreover, an should allow MPCs to differentiate medical companies in order to offer adjustment of the marketing model themselves from competitors, services, including telemedicine, is to be considered: instead of solely ensuring consumer stickiness and post-diagnosis follow-up solutions relying on sales representatives enabling growth in the long term. and data analysis. The main reason visiting clients, companies may In foreign mature markets (such as for this trend is that in the domain apply more effective and economic the U.S.) such attempts have already of chronic diseases, such as vascular methods, especially considering been explored. Pharmaceutical diseases, diabetes, central nervous the fact that doctors in grassroots companies have launched user-based system diseases, etc., patients markets need more education on mobile medical devices, improving are reliant on long-term and high diseases and products as well as patient medication adherence and frequent monitoring and caretaking. scientific dialogues and information participation. For instance, Johnson Using mobile medical companies’ about the curative and cost effects of & Johnson gathered comprehensive technologies, allows MPCs to improve the products. user data by upgrading their devices; the curative effect of drugs and Sanofi and GlaxoSmithKline launched patient medication adherence. Thus, pharmaceutical companies need products that target specific diseases to enhance their marketing personnel and used them to follow the entire training, turning them into sales progression of the targeted diseases. representatives covering the entire product catalog. At the same time, Among various new business models, they may use digital channels, medical many MPCs applied the so-called personnel, interactive seminars and “Internet+” model. trainings to encourage doctors to participate in conversations about As the Internet medical wave topics they are most interested in. is spreading across the world, “Internet+” brings various advantages to MPCs, including information dissemination among doctors – offsetting the weakness of marketing coverage –, improved communication between doctors and patients, as well as the implementation of disease management platforms to increase patient stickiness.

16 New Healthcare Reform in a New Era

Overview of collaborations between MPCs and Internet companies

Pharmaceutical Partners Date Projects Companies

Jointly established doctor-patient communication May 2015 platform and health management of chronic disease such as diabetes and cardiovascular disease

Pooled quality resource, exploring chronic disease June 2016 management and O2O model

Jointly established China Alliance of Respiratory Disease, April 2015 conducting chronic disease management for patients with asthma and COPD

Jointly established China’s first hierarchical medical January 2016 system for vertical disease

Jointly established the integrated chronic disease management system, conducting grassroots level doctor April 2016 training, patient education and disease management combining both online and offline method

Collaborated in the professional medical warehousing, May 2015 cloud hosting of chronic disease management data, and health data analysis business

Collaborated in the "Power+" Postprandial Glucose April 2016 Optimization Management Platform project in China

To help people living with diabetes access adequate February medical resources and disease-prevention education, 2017 Lilly, together with Tencent and DXY initiated Lilly Connected Care Program, or LCCP.

Data: Public Information, Deloitte Analysis

Additionally, collaborations with patients, and thus to increase drug and even production chains. On the insurance companies are becoming sales volume; in return, Roche can other hand, insurance companies increasingly significant. In 2012, Roche provide cancer statistics to insurance may obtain more comprehensive data and Swiss Reinsurance Company companies allowing them to design to manage their product risks. Thus, collaborated with five Chinese better insurance products based on collaborations have great commercial insurance companies on promoting treatment risk and cost calculation. potential, especially in the field of cancer insurance in China. This On the one hand, collaborations chronic disease management. collaboration project allows Roche give pharmaceutical companies the to lower drug prices for insured opportunity to expand their sales

17 New Healthcare Reform in a New Era

Conclusion

As the healthcare reform progresses, Still, with the healthcare reform, Yet, there is room for MPCs to grow MPCs are facing an increasingly MPCs will also benefit from a more in China's market. A market with the challenging environment. Strict standardized industry environment. greatest growth potential in the world, regulations of the entire medicine For instance, compliant MPCs with a and perhaps the biggest market industry, with a focus on cost control self-managed sales team benefit from that is yet to be developed. Hence, and compliance are key components the implementation of a two-invoice despite the pressure caused by the of the health care reform and put system, since it restrains certain healthcare reform, MPCs have plenty considerable pressure on MPCs’ profit domestic generic drug manufacturers of room to develop their business in rates. More precisely, cost control from conducting rebate sales. China. If MPCs achieve to adapt to measures, including a capped total Furthermore, the inelastic market China’s policies and market trends healthcare insurance expenditure, demand caused by an ageing society and reconstruct their strategies controlled drug sales proportion and urbanization will stimulate the accordingly, they will still be able and a strict centralized procurement industry, and the multi-dimensional to seize market opportunities and policy, will make it more and more policies will ensure a healthy growth develop new competitive advantages. difficult for MPCs to keep their overall of the market. Conducting localized production and margin at the current level. R&D and developing business in the grassroots medicine markets will help MPCs to lower costs, better serve Chinese patients’ needs and increase their market share. Furthermore, collaboration with other related industries at a deeper level will help MPCs to establish an ecosystem and product chains – and to finally achieve a successful transition in China’s reforming medicine market.

18 New Healthcare Reform in a New Era

Meet the team

For more information, please contact:

Yvonne Wu Leading Partner Deloitte China Life Sciences & Health Care Email: [email protected] Tel: +86 21 6141 1500

Maria Liang Tax & Legal Managing Partner Deloitte China Life Sciences & Health Care Email: [email protected] Tel: +86 21 6141 1059

Mike Braun Financial Advisory Managing Partner Deloitte China Life Sciences & Health Care Email: [email protected] Tel: +86 21 6141 1605

Andrew Yu Consulting Managing Partner Deloitte China Life Sciences & Health Care Email: [email protected] Tel: +86 21 2316 6913

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