For Global Drug Manufacturers, China Becomes a Perilous Market

July 16, 2013

For Global Drug Manufacturers, China Becomes a Perilous Market



Multinational drug companies now employ more sales agents in China than they do in the United States, their largest market. Several, including Merck and GlaxoSmithKline, are making huge scientific investments in the country, including building research and development centers. Within the next few years, China is poised to surpass Japan as the world’s second-largest pharmaceutical market. The booming Chinese demand for drugs could not come at a better time for Western manufacturers, whose sales have been slumping because of patent expirations in the United States and stringent price controls in Europe.But selling pharmaceuticals and other health care products in China is increasingly fraught with peril, as shown by accusations in China this week that GlaxoSmithKline funneled payments through travel agents to doctors, hospitals and government officials to bolster drug sales in the country.

Chinese officials have compared the company’s operations to organized crime and have detained four Chinese executives for questioning. Shortly after government investigators raided the Shanghai offices of Glaxo last month, the British executive in charge of the company’s Chinese operations left the country. He has not been back since.

Earlier this month, the top manufacturers of infant formula, including Abbott and Nestlé, lowered their prices in China under government pressure, and Chinese officials have said they are investigating the pricing policies of up to 60 foreign and domestic drug companies.

The rash of investigations is one measure of how critical the health care market has become to global companies — and to the Chinese government. The Chinese have made no secret of their goal of pushing the country’s domestic drug industry into more direct competition with the world’s top manufacturers.

As a result, global companies can expect more scrutiny, said Tarun Khanna, a professor at Harvard Business School who has studied foreign investment in China. “Practices that may have been O.K. some time back may be more scrutinized by foreigners now,” he said, especially as the government seeks to shift from an export-based economy to one that is also focused on selling to Chinese consumers. “They’re trying to get more balance back.”

Several factors are contributing to the boom in China, experts said. China’s growing economy has given rise to a middle class that is increasingly able to afford expensive Western drugs, and to treat conditions — like depression and respiratory illnesses — that may have otherwise gone undiagnosed or unmedicated.

And under a new health care program, China has expanded insurance coverage to hundreds of millions of new patients — 95 percent of the population had insurance in 2011, compared with 43 percent in 2006, according to a recent report by the consulting firm McKinsey & Company. By 2020, China’s total spending on health care is expected to grow to $1 trillion, from $357 billion in 2011, according to McKinsey.

Even as foreign companies raise their investment, the Chinese are also looking to capitalize on the booming health care market. The government identified the medical industry as one of seven major areas for development in its most recent five-year economic plan, and the country’s medical sector invested $160 billion in research and development in 2012, nearly surpassing Japan, according to a recent report by the Boston-based Lux Research.

“China is interested in building a very strong, homegrown industry,” said Kevin Pang, a research director at Lux.

But some believe Western companies will have an edge because consumers may be willing to pay more for brands that are known for high-quality ingredients.

“There are so many drugs that are poor quality in China, so the ability to differentiate yourself is important,” said Craig A. Wheeler, the chief executive of the American generic drug maker Momenta Pharmaceuticals. His company is developing complex drugs known as biosimilars through a business deal with Baxter, which has an established presence in China.

Mr. Wheeler said the recent crackdowns were to be expected. “These markets are maturing, and these markets are going to be therefore more highly regulated,” he said.

GlaxoSmithKline has been struggling to rebuild its image after a $3 billion fine in the United States last year, in which the company admitted to improperly promoting its antidepressants and failing to report safety data about the diabetes drug Avandia. Andrew Witty, who took over as chief executive in 2008, has repeatedly pitched the company as a global leader in ethical practices and said it had moved on from its previous lapses.

Chinese investigators told a different story on Monday, however. At a news conference in Beijing, they said senior executives had organized fake conferences, overbilled for training sessions and paid kickbacks in cash and luxury travel. The illegal activity was funneled through travel agencies, authorities said, some of whom even hired young women to engage in “sexual bribery,” or activities, with Glaxo managers to win long-term contracts with the company.

The Chinese government said it had detained four senior executives — all Chinese nationals — but noted that the British head of the Chinese operations, Mark Reilly, had left the country shortly after authorities raided their offices.

A company spokesman confirmed that Mr. Reilly left China about 10 days ago, and that he was currently working from the company’s offices in Britain. He declined to comment on whether Mr. Reilly planned to return to China.

On Monday, one of the detained executives appeared on Chinese television and admitted to much of the activity, according to news reports. In the interview, Liang Hong, the vice president of operations for Glaxo in China, acknowledged organizing fake conferences and other activities, and said the payments that were made to doctors and government officials contributed to the higher prices of the company’s drugs in China.

In a statement, Glaxo said it was “deeply concerned and disappointed” by the accusations. “GSK shares the desire of the Chinese authorities to root out corruption,” the company said, adding that it had stopped its relationships with the travel agencies identified in the investigation and was reviewing past transactions with them. “These allegations are shameful and we regret this has occurred.”

While some said the investigation was unusual both for its scope and the forceful actions taken by the Chinese government, several analysts said that on some level, such activities are typical of foreign companies seeking to do business in China and other emerging markets.

“Most large-scale bribery investigations focus on the use of intermediaries,” said Richard L. Cassin, who is editor of the FCPA Blog and a lawyer who specializes in such cases. But he said that the accusation by Chinese authorities that Glaxo channeled as much as 3 billion renminbi (about $489 million) through more than 700 travel agencies makes this case more egregious than most. “The question of 700 travel agencies, it’s an astounding number,” he said.

Such practices have attracted growing attention from the United States, which is investigating several large pharmaceutical companies, including Glaxo, according to financial filings.

Last year, the American drug maker Eli Lilly agreed to pay $29 million to settle charges filed by the Securities and Exchange Commission that it had used third parties to funnel bribes to overseas government officials. In China, employees at a Lilly subsidiary falsified expense reports to provide spa treatments, jewelry and other gifts, S.E.C. officials said. Pfizer and the medical device maker Biomet have also recently settled federal charges of bribery in China and other countries.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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