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»03/03/2007 [Independent reports]
Challenges Facing Chinese Domestic Pharmaceutical Industry

A Report by: Dominique Ding Professor Hauskrecht G400 Economic Consulting March 3rd, 2007


Challenges Facing Chinese Domestic Pharmaceutical Industry

Report Objective

This report explores the uniqueness of the domestic Chinese pharmaceutical industry by focusing on the challenges it faces. The size, growth, and trend of the Chinese pharmaceutical market will be touched upon to provide a context for the discussion on its risks. As this report focuses on challenges facing domestic Chinese pharmaceutical companies, key differences between domestic companies and multinational presence in China will be introduced. Challenges facing domestic Chinese pharmaceutical companies elaborated upon include regulatory risks, complications arising from the prevalence of counterfeit drugs, pressure due to globalization, and difficulty in accessing capital.

Chinese Pharmaceutical Industry Overview

According to government figures, there are currently 3500 drug companies in China, falling from more than 5000 two years ago, a decline that is expected to continue. Domestic companies compete in a $10 billion market without a dominant leader. (Pharmaceuticals in China) At present, China is the world’s ninth largest drug market, and is expected to become eighth and fifth largest, respectively, in 2008 and 2010. (Bennett) The industry has experienced an annual average growth rate of 16.72% over the last few decades. (Research and Markets) Despite notable progress, the domestic industry is still small-scale, geographically dispersed, with low R&D activities and outdated manufacturing technology.

The Chinese domestic pharmaceutical industry has relatively low market concentration, weak international competitiveness, and low quality perception, accompanied by a lack of patented pharmaceuticals developed in-house. According to Business China, domestic drug makers account for 70 percent of the market, with a 20% market share for the top 10 companies. (Pharmaceuticals in China) In contrast, the top 10 companies in most western countries control about half the market. Foreign drug makers in China account for 10% to 20% of overall sales, depending on the types of products included in the count and according to IMS Health Inc., sales from such foreign firms are growing at a slower pace than that of top domestic drug makers. (Pharmaceuticals in China) However, even top selling domestic drug makers seldom exceed annual sales of $100 million.

Around 36% of China’s pharmaceutical enterprises are state-owned. Another 35% are privately owned domestic enterprises and the remaining 29% are foreign-funded. Synthetic drug manufacturing remains the pharmaceutical industry’s largest business in China, constituting 65% of industry sales. (Pharmaceuticals in China) Another 21% of industry sales come from traditional Chinese medicine. Biotech-related medical products and medical equipment make up the rest. Hospitals are the largest source of demand. (Seeking Alpha)

Since the Chinese economic reforms towards openness in late 1970s, the Chinese drug market began opening up to the world, challenging the domestic Chinese pharmaceutical industry by creating an environment more conducive for foreign competitors. By 2003, sales of imported drugs have occupied one fifth of the Chinese pharmaceutical market. China’s entry into the World Trade Organization and its integration into the global economy will further intensify the competition faced by Chinese domestic drug makers from multinationals.

Domestic versus Multinational Companies

Compared with Western pharmaceutical giants, Chinese companies are technologically weaker and smaller with less capital access and a lower R&D budget. However, many Chinese companies not only produce the pills but also own the pharmacies where they are sold, as well as the delivery networks to the hospitals where 80% of drugs are distributed. (Seeking Alpha) Furthermore, Chinese companies can produce generic versions of branded drugs cheaply.

The Chinese government is highly paternalistic in regulating the pharmaceutical industry and market dynamics make competition intense. A key difference between domestic drug makers and multinationals in the Chinese pharmaceutical market is that Chinese drug makers mainly engage in generic manufacturing. This introduces interesting questions as for exactly how the lack of intellectual property protection in China affect domestic pharmaceutical companies, as it supports that they might in fact benefit from some of China’s current systematic flaws.

Regulatory Challenges Facing Domestic Companies

The pharmaceutical industry in China is subject to extensive government regulation and supervision. The regulatory framework addresses and lacks visibility in addressing all aspects of operations including approval, production, licensing and certification requirements and procedures, registration of new drugs and environmental protection. Corruption at any regulatory stage will alter natural market dynamics. This suggests that solid "guanxi", an ambiguous term in Chinese for "relationship", between business entities and governmental agencies is paramount and creates an environment conducive for corruption. (This report later touches upon how perhaps corruption has become such a norm in Chinese business that its sudden heavy policing, ironically, creates more problems for individual companies.) The fact that some pharmaceutical companies are state-owned while others are private further invites potential inherent biases from regulatory and judicial authorities.

Although it is China so we can assume that there is personal corruption, most risks faced by companies in the pharmaceutical industry are nonetheless linked to regulatory inadequacies or systematic flaws. Although domestic companies, being mostly generic drug makers, might benefit from China’s inadequate patent protection system at the cost of more innovative multinational companies, arduous, unpredictable, and nontransparent intellectual property protection procedures are nonetheless a double-edged sword that threatens any company that engages in research and development, including domestic drug makers.

The Patent Problem:

The process of seeking patent protection in China is often lengthy and expensive. The concept of intangible ownership is still a fairly novel and uncomfortable notion to the Chinese. Pharmaceutical inventions were not patentable under the China Patent Law until 1994. (3SBio) Intellectual property rights and confidentiality protections in China are less rigorous than that of western nations, due to factors including lack of procedural rules for discovery and evidence, low damage awards and lack of judicial independence. (3SBio)

Implementation and enforcement of Chinese intellectual property-related laws have historically been deficient while corruption and local protectionism have been rampant. The monitoring of unauthorized use of proprietary technology is difficult and expensive, as is resorting to litigation to enforce or defend patents. The experience and capabilities of Chinese courts in handling intellectual property litigation is also limited and outcomes are often unpredictable. (Zhou)

Dependence on Administrative Protection:

Under China’s first patent law enacted in March 1984, drugs were not eligible for patent protection. This law, however, provided patent protection for the manufacturing methods of pharmaceuticals. (3SBio) The Drug Administration Law of 1984 specified that pharmaceutical products that had never been manufactured in China were classified as new drugs, and allowed Chinese pharmaceutical companies to produce drugs that are similar in structure and function to foreign drugs so long as the foreign drugs had not been manufactured inside China. (Zhou) To further protect the domestic pharmaceutical industry, the State Drug Administration issued the 1999 Regulations, which provided a six to twelve year administrative protection period for five categories of new drugs. (3SBio)

Many domestic drug makers are currently highly dependent upon administration protection to protect their intellectual property. The period of administrative protection under these Chinese pharmaceutical regulations is much shorter than that offered under patent protection which lasts up to 20 years. Once an administrative monitoring period expires, companies become vulnerable to a new wave of competition unless they can mobilize market mechanisms or seek other intellectual property protection.

Litigation Risk:

The domestic Chinese pharmaceutical market is dominated by generic manufacturers; consequently, such domestic companies face high risk of infringing upon third party intellectual property rights. Interestingly, as one would think that a lack of solid intellectual property protection should necessarily benefit copy-cat producers, the same type of regulatory deficiencies also makes it hard for a generic drug producer to know for sure when it is not infringing upon another’s property rights.

Unlike the U.S. which operates under a "first to invent" system under which whoever makes the first actual discovery will be awarded the patent, China employs a "first to file" principle. (Zhou) Under the first-to-file system, even after reasonable investigation, a company may not know for sure whether it has infringed a third party’s patent because such third party may have filed a patent application without the company’s knowledge while the company is still in development phase.

Government Intervention on Pricing:

Pricing of pharmaceutical products in China is generally subject to government approval. The pricing mechanism is based upon three considerations when setting the maximum retail price - production cost, a wholesaler spread set by the government and the prices of comparable products in the market. ((Pharmaceuticals in China) Any products priced above this level will be cut. The competitive bidding in effect sets price ceilings for products, limiting industry profitability. In some instances, if the price range designated by the provincial government falls below production costs, companies must respond by stopping the manufacturing of certain products. One industry executive describes this as "the biggest challenge our industry has ever faced". (Chang)

Risk of Anti-corruption Initiatives:

It seems a bit ironic that government-led anti-corruption measures should adversely affect such a virtuous industry, but things are counterintuitive in countries where corruption counts as corporate strategy. The government has recently taken anti-corruption measures to discourage practices such as bribery, acceptance of kickbacks, or other illegal gains or benefits by hospital officials from pharmaceutical distributors. For domestic companies historically enjoying corruption as a form of currency, such initiatives may adversely affect future cash flows.

Even manufacturers unengaged in corruption may be concerned about this. For many domestic companies, sales to end-users are conducted through third-party distributors, many of whom are corrupt. If a company’s downstream distributors engage in corruption and the government takes enforcement action, products may be seized and a company’s own practices and involvement in the distributors’ practices could be investigated, leading to public relations disasters.

  Furthermore, government-led anti-corruption campaigns can have an adverse effect on marketing efforts. Many company sales representatives rely on hospital visits to promote brand awareness. One company, 3SBio, cites that since the focus on anti-corruption, there have been occasions on which its sales representatives were denied access to hospitals in order to avoid the perception of corruption. (3SBio)

Real Pain from Fake Drugs

Although Chinese demand accounts for only 1.5% of the global drug market, China can claim supplier status for most of the world’s fake drugs. (Pharmaceuticals in China) The problems fake drugs introduce are messy, ranging from moral concerns to classic information asymmetry that hurts both consumers and drug makers. Perhaps the most troubling aspect of fake drugs is that it cannot be solved using regulation, as it already violates every rule in the book. This reduces the problem to enforcement, a more arduous process. In fact, counterfeit expert David Fernyhough cites that "the problem (counterfeit drugs) is so massive that no enforcement is going to stop it".

Counterfeit drugs have tremendous effects on companies producing successful drugs worth faking. Any harmful effects resulting from a counterfeit drug could seriously tarnish the brand equity associated with the original legitimate drug. Fake drugs increase the quantity of products on the market, lowering prices of legitimate products. Consumers, equipped with a healthy dose of skepticism in response to the prevalence of counterfeit products, and unable to distinguish fake drugs from the authentic, may reduce the price they are willing to pay, further adversely affecting prices of legitimate products. The prevalence of fake drugs also puts pressure on the quality of the downstream distribution channels for authentic pharmaceutical products. Cautious consumers in China often only purchase medicine from establish, well-known venues. This restricts the range of distribution possibilities for legitimate producers.

Challenges of Globalization

China’s integration into the global economy, most notably its accession to the WTO in 2001, introduces international competition that places an intense pressure on the domestic pharmaceutical industry and further opens the door for multinational companies. China’s WTO commitments include the tightening of rules on intellectual property, tariff concessions, and market access of non-Chinese service suppliers engaging in the distribution of pharmaceuticals. All such moves are conducive for foreign activity in this industry. It is anticipated that with the lowered or eliminated tariffs, foreign companies will offer higher quality products at competitive prices. Furthermore, due to the lack R&D capital, most of the domestic pharmaceuticals are imitations of foreign products. Following China’s accession to the WTO, an increase of companies in Europe and the U.S. have already applied for patents in China, escalating the threat of litigation for domestic pharmaceutical companies. (3SBio)

Challenges in Raising Capital

Lack of intellectual property protection in China exacerbates another serious challenge facing the domestic pharmaceutical industry; the difficulty in raising capital. The domestic pharmaceutical industry already operates in the context of an underdeveloped domestic capital market. Venture capitalists often only invest in companies with protected technologies and a ready capital market for exit opportunities. While intellectual property protection is improving in China, and exits are possible on the NASDAQ market through an offshore or US-based incorporation, most venture capitalists remain cautious while those that do invest must be ready to face certain foreseeable complications. According to China Business Review, as most Chinese pharmaceutical companies lack sufficient capital and most domestic venture capitalists lack an understanding of the pharmaceutical investment paradigm in developed countries, pharmaceutical companies are often forced to adopt complex business models that generate cash flow from a non-core activity, such as distribution. Often the non-core activity distracts the company from promising projects. (China Business Review)

In later financing stages for a domestic pharmaceutical company, although it is possible to undergo an Initial Public Offering on the NASDAQ in response to the unsophisticated nature of the domestic Chinese capital market, this comes with a unique set of challenges as well. Many investors are understandably skeptical of Chinese idiosyncratic reporting and obscure figures. Most domestic companies seeking capital in the U.S. have previously operated as private companies with no experience complying with U.S. public company requirements or preparing financial statements in accordance with U.S. GAAP.


This report, while seeking to be objective, is also an expression of skepticism towards what the author sees as an unhealthy optimism so prevalent among bandwagoners towards anything containing the word "China" nowadays. For this reason, this report chose risks as its focus, which is often overlooked, as opposed to industry advantages which are more obvious. China’s domestic pharmaceutical industry’s strengths, including high vertical integration, low-cost, fast imitation, highly skilled researchers, advantageous policies and tax treatment, as well as China's overall macro potential, all indicate a promising future. However, until the country refines and enforces its regulatory efforts, promotes more conventionality into business practices, and better develop its capital markets, even China’s most promising industries may remain paper tigers for sometime to come.


Works Cited


3SBio Inc. "3SBio IPO Prospectus." SEC Public Filings. 06 Feb. 2007. 03 Mar. 2007


"Beijing Med-Pharm: China's One Stop Shop For Western Drugs" Seeking Alpha 2007. 04. Mar. 2007. <>


Bennett, Johanna. "Big Pharma Sees China's Big Opportunity" Barrons. 2005. 01 Mar. 2007.

Carnes, David. "Intellectual Property Protection in China" Ezine Articles. 2007. 02 Mar. 2007.


Chang, Leslie. "China Wants to Set Drug-Price Caps, Angering Pharmaceutical

Companies" WSJ. 2007. 02 Mar. 2007. <>

"Chinese Pharmaceutical Industry" Research and Markets. 2006. 02 Mar. 2007. <>

Chervenak, Matthew. "An Emerging Biotech Giant?" China Business Review. 2007. 04 Mar. 2007. < <>

Jonsson, Annette. "Strong IPO Demand For 3SBio, but Shares Fall on Debut."

Finance Asia. 2007. 05 Mar. 2007. <>

Oliver, Chris. "China share rout weighs on regional markets" Market Watch. 2007. 04 Mar. 2007. << >>

"Pharmaceuticals in China" Wikipedia, The Free Encyclopedia. 16 Feb 2007, 07:26

UTC. Wikimedia Foundation, Inc. 03 Mar. 2007


Zhou, Eliza. "Chinese Biogenerics and Protection of IP" GEN. 2007. 02 Mar. 2007.





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