Driving Growth in the

Turbulent Chinese
Pharmaceuticals Market
Part 2: Developing deep market insights, ensuring comprehensive market access,
managing an expanding sales force, establishing reliable distribution channels

October 2008 Franck Le Deu

Rajesh Parekh
Jin Wang
2
 3

Most multinational pharmaceutical companies (MNPs) continue to view China

as a significant opportunity. After a somewhat slow year in 2006, the market
for prescription drugs rebounded in 2007 (growth was about 25 percent) and is
on track to increase by more than 25 percent in 2008. The country is expected
to be one of the global top-five pharmaceutical markets by 2012, with annual
sales of US$48 billion (Exhibit 1). Several MNPs have stated that they aim to
reach US$1 billion in annual sales in China within the next few years.

Exhibit 1

Overall, market growth continues to be strong

China pharmaceutical market*

US$ billions**

48 Over the next five

years …
• China will become a
+23 global top 5 pharma
market

25 • 2nd largest market in

terms of absolute
+13 growth in market size
12 • 2nd largest country in
terms of sales force
size for most MNPs

2004 2008E 2012F

* Ex-manufacturer value; does not include over-the-counter and traditional Chinese medicine market
** Assume exchange rate of 1 US$ = 6.8 renminbi
Source: IMS; McKinsey analysis

However, several characteristics – not just its scale – combine to make the
Chinese pharmaceutical market challenging. It is extremely heterogeneous;
for example, access to physicians and hospitals varies markedly, as does
the availability of health insurance. Reliable data to track drug sales do not
always exist, and outside the major cities, distribution can be difficult. The
market is also changing rapidly. The government is mandating health-care
reforms, income levels are rising, and patients are taking a more active role
in treatment decisions. Furthermore, local pharmaceutical companies are
becoming increasingly sophisticated and more willing to compete directly with
MNPs.
4

As a result, the level of skill that enabled MNPs to succeed in China will
be insufficient to allow them to maintain their fast growth trajectory. More
sophisticated capabilities are necessary.

This is the second of two articles on what MNPs must do to succeed in China.
In our first article1, we discussed strategy – how these companies should think
about driving growth in the market and what choices they should consider
when it comes to their product portfolios, their approach to physicians and
patients, and their prioritization of territories. Here, we focus on the four core
capabilities that MNPs must have to execute their strategies successfully in
China: the ability to develop deep market insights, to ensure comprehensive
market access, to manage an expanding sales force effectively, and to
establish reliable channels for drug distribution and retail sales. We explain
why these core capabilities are so important in China and outline what MNPs
must do to acquire them.

1 “Driving Growth in the Turbulent Chinese Pharmaceuticals Market” 2007. For a copy of this
article, contact the authors.
Market Insights
5

Most MNP executives in China know, in broad strokes, what factors are driving
the pharmaceutical market’s growth in China and their own performance here.
However, their companies often have only a superficial understanding of the
market’s dynamics, and thus many MNP executives have admitted to us that it
is difficult for them to set appropriate performance aspirations, to identify the
drivers of under- and over-performance, or to fully comprehend the market’s
competitive dynamics. They also find it hard to predict how the market will
evolve, given its uneven growth rate (Exhibit 2). As a result, these executives
are concerned that they will miss out on potential growth opportunities or be
caught by a sudden market slowdown. The inability to anticipate and quantify
the market’s drivers is becoming a much greater source of concern because
growth in China is becoming more visible – and more important – to their
corporate headquarters. Thus, MNPs must develop deeper insights into the
market here.

Exhibit 2

Year-on-year market growth is highly variable

China pharma market year-on-year growth Potential disruption

Percentage factors
30
30 • Slowdown in real GDP
25 25 growth
25 23
21 • Renewed anti-corruption
CAGR
20 drive
=20%
14 13
15 • Broader price controls
10 8 • Scope of essential drug
Anticorruption policy implementation
5
campaign
0
01 02 03 04 05 06 07 08E

Source: IMS; McKinsey analysis

Market intelligence is a key success factor in any country, but it is crucial in

China – the market’s complexity and pace of change will reward companies
that can build a competitive advantage in this area. To develop superior
market-insight capabilities, MNPs in China should keep the following three key
principles in mind.
6

Granularity
MNPs must start thinking at a much more granular level about the country
and the drivers of market growth here. China is not one monolithic market but
a set of sub-markets, each of which has different characteristics. Among the
factors that must be considered separately in each region are the prevalence
of specific diseases, the distribution of incomes (and how fast incomes
are rising), the percentage of the population with access to physicians and
hospitals, and the breadth and depth of medical insurance coverage. We have
seen clients alter their estimate of demand for a given drug by a factor of three
or four once they conducted a more granular assessment of these factors.

To think more granularly, MNP executives must start by asking the right
questions. For example: How fast will the new health-care policies promulgated
by the central government be implemented at city level? What impact will
community health centers have on patient flow for primary-care conditions?
What are the specific drug-class dynamics in China, and how do they differ
from global dynamics? What is the real competitive landscape (Exhibit 3)?

Exhibit 3

Proper market definition needed to understand real competitive dynamics

%, US$ millions CNS EXAMPLE

MNP definition of the market … … and the right definition

Value share MNP market MNP A
Value share total market MNPs
MNP B Locals
MNP C

100% = 36 40 43 61 73 100% = 41 57 70 106 147

8 11 15 20 24
30 50
34 62 57
40 69
43 87
42

62
55 50
45 43
37 34 38
31
13

2004 05 06 07 2008E 2004 05 06 07 2008E

Company A gaining share

Locals – real winner of the game
against other MNPs

Source: IMS; McKinsey analysis

 7

Triangulation
In China, no source of information is sufficient by itself. MNP executives must
therefore apply their business judgment wisely while triangulating among
multiple sources of information if they want to generate real insights.

In general, third-party market research is not as reliable in China as it is in

more developed countries, but it is nonetheless valuable. There are numerous
sources of quantitative data, including IMS (which monitors prescription data,
primarily in the urban markets) and the Ministry of Health’s hospital database
(which provides annual data on the consumption of Western drugs, among
other things). MNPs can also leverage their field forces to collect valuable
hospital-level data. There are two keys to getting good results from the data:
First, MNPs must invest up front by carefully structuring the research. Second,
they must remember that the absolute numbers reported may not be accurate
– but the trends generally are.

Ultimately, MNPs must find the right balance between “boiling the ocean”
(over-investing in attempts to get highly accurate data) and staying at a
somewhat superficial and deceptive level of market understanding.

Institutionalization
In our experience, MNPs in China often generate useful market insights but
then fail to link them properly to business decisions. We believe that these
companies would be well served by increasing their investments in processes
that would allow them to fully capitalize on their market insights. For example,
an MNP could designate a specific function as responsible for the market-
insight generation process, institutionalize the analyses to be performed and
the sources of data to be obtained (to limit the impact of employee turnover),
and – most importantly – link all market insights to its strategic-planning and
brand-building efforts. Once these processes are in place, the company should
ensure that its market insights are refreshed on a regular basis.

On its own, the ability to generate good market insights is not sufficient to
ensure success in the Chinese pharmaceutical market. But it will be almost
impossible for MNPs to win in China without it, and if properly executed it can
become a source of competitive advantage.
 Market Access
8

Even the best market insights will be useless if market access restrictions
prevent uptake of a new drug. Often, even the best laid-out plans for
product uptake are hindered in China because companies have not invested
appropriately in ensuring broad market access. Establishing good market
access typically requires an MNP to surmount three hurdles: get the product
on China’s reimbursement drug list (RDL), convince individual hospitals
to include the drug on their formularies, and successfully negotiate the
tendering/bidding processes in each province. We discuss each of these
hurdles briefly below. MNPs should remember, however, that market access
is yet another area in which there are significant variations among provinces,
cities, and even hospitals; these variations must be monitored and managed
if a company wants to ensure good market access.

Reimbursement drug list

Although most health-care expenses in China continue to be paid for out
of pocket, the role of insurance is steadily gaining. Therefore, most drugs
benefit significantly – both directly and indirectly – by being included on
the RDL. For example, the drugs become reimbursable under China’s basic
medical insurance (BMI) program, which already covers 180 million people in
the country’s cities and is expected to include more than 250 million urban
residents by 2015 (Exhibit 4). Inclusion on the RDL significantly improves

Exhibit 4

Fast expansion of insurance coverage

Insured population (millions)

Basic Medical Insurance for urban Urban Cooperative Medical

employees (BMI) Scheme (UCMS)

>350

>250

180
160

50
10

2006 2007 2015F 2006 2007 2015F

| 3
Source: MoH; MoHRSS; McKinsey
 9

affordability, because it lowers patients’ co-payments to 0 to 40 percent

of each drug’s cost. And because RDL-listed drugs are more affordable for
insured patients, hospitals and pharmacies are more likely to stock them.
Furthermore, because many Chinese physicians perceive inclusion on the RDL
as a stamp of approval from the government, they are more apt to prescribe
listed drugs, even to patients without BMI coverage. Thus, an RDL listing can
have a significant impact on a new drug’s trajectory in China (Exhibit 5). The
uptake of a new drug can be severely restricted by the lack of an RDL listing,
especially in drug classes with alternatives already on the RDL.

Exhibit 5

RDL listing has been a critical driver of products’ uptake ONCOLOGY EXAMPLE
National RDL issued
Sales volume RDL implemented in most provinces
Million units

Xeloda Eloxatin
(Roche) (Sanofi-Aventis)
+44% 231 +25% 58
51
186 43
170 +17%
+33% 32
117 24
18 20
15
54
23 29 29

H1 H2 H1 H2 H1 H2 H1 H2
H1 H2 H1 H2 H1 H2 H1 H2
2004 2005 2006 2007
2004 2005 2006 2007
Sales growth signficantly
accelerated upon RDL entry
Arimidex
(AstraZeneca)
71
+56%
51
37
+44% 25
12
4 4 6

H1 H2 H1 H2 H1 H2 H1 H2
2004 2005 2006 2007

Source: IMS

There is some debate around the importance of the RDL for newly launched
high-cost therapies (e.g., targeted antibody therapies for cancer). It is true that
many patients would be willing to pay out of pocket for these drugs. Our sense,
however, is that companies would still want to pursue an RDL listing for most
of them – the expanded size of the addressable patient pool would outweigh
the potential negative impact on price that comes with an RDL listing2.

2 Inclusion on the RDL typically requires pharmaceutical companies to accept limits on the price
they can charge for products as they come under NDRC price review. For some innovative
drugs, some companies may decide to accept the loss of market share caused by exclusion
from the RDL rather than to lower prices.
10

An even stronger argument in favor of RDL listing is that most new drugs enter
competitive markets; a company would face a long-term selling challenge if
it chose not to pursue an RDL listing for its drug but a competitor pursued
one for a similar product. Furthermore, the RDL’s importance may increase
in the next few years, because the new insurance program now being rolled
out for the remainder of the urban population, the Urban Cooperative Medical
Scheme (UCMS), may also use the RDL as the starting point for determining
which drugs to pay for.

Getting a drug on the RDL is not easy, however. Government policy suggests
that the list be updated every two years, but the actual gaps between updates
have been far longer. All drugs launched since the last update in 2004 must
wait for the next review, which is not expected until at least 2009. However,
the responsible government agencies have not yet laid out the processes that
will be used for the next review, which leaves open many questions around
eligibility criteria, review criteria, and the like.

Another complication is that the process for obtaining RDL inclusion is tiered.
The national review may be the most important part of the process, but each
province is allowed to add drugs to the list, and cities are also permitted to
influence its final composition. Thus, MNPs must build up their capabilities
at the national, provincial, and city levels to effectively manage the process
of getting their drugs on the RDL. It is particularly important that these
companies be skilled in three areas:

KOL management. The national and provincial reviews are strongly influenced
by recommendations from a small set of key opinion leaders (KOLs), some of
whom may not be among the opinion leaders that MNPs cultivate as part of
their normal sales/marketing efforts. Companies should therefore develop a
systematic map of the KOL networks in China and seek to identify the opinion
leaders who are likely to be part of the RDL review process. The companies
should also develop a clear value story (grounded in the Chinese market
context) for why their particular drug should be added to the RDL and then
disseminate that message to the KOLs.

Government affairs effectiveness at all levels. Given the lack of transparency

and multi-tiered nature of the RDL process effectiveness at all levels, MNPs
must invest in building their government affairs organizations so that they can
 11

develop the experience, insights, and capacity to manage the process. During
the last review cycle, for example, several leading MNPs with good insights into
provincial dynamics were able to get many of their drugs onto some provincial
RDLs, even though they had missed the window for the national RDL.

Local clinical data/physician adoption: The RDL review committees are

putting increasing emphasis on China-specific clinical evidence, and thus
drugs that lack compelling local data to support their use are likely to be
at a disadvantage, especially when competing against drugs that have such
data. Furthermore, establishing local data provides a second advantage: it
helps expand physician usage, which is another important criterion in the
RDL review. Therefore, MNPs should make the need for local Chinese data an
important consideration in their early global clinical development processes
and also step up their post-market trial activity in China.

Increasingly, an RDL listing is becoming a make-or-break issue for many

drugs. MNPs must therefore make sure that they put their best effort into the
application process, and leverage their cross-functional resources to enhance
the chances of success.

Hospital listing
Getting on hospital formularies is an essential requirement for product uptake
in China – in the absence of a hospital listing, the likelihood that physicians
will prescribe a given drug is very small. Most hospitals have a set process for
deciding on formulary status (in most cases, a committee reviews new drugs
and decides which ones are approved). Unfortunately, though, the decisions
are still made on a hospital-by-hospital basis.

In the past, hospital listing was a relatively straightforward process that MNPs
could treat largely as a tactical exercise. This may be changing, though.
Government policy is now strongly encouraging hospitals to implement
new rules that limit formularies to two brands per molecule. Our recent
interviews with executives from more than 50 Chinese hospitals indicate
that many of them are beginning to implement this policy, although variations
in implementation will persist for the near term. We also found that most
hospitals implementing the new rules are approving one brand from an MNP
(usually the innovator) and another from a local company (usually a leading
branded-generic manufacturer). This is expected to lead to a decline in the
12

number of generic products (unbranded drugs, in particular), a change that

could well be favorable for MNPs, especially those that are able to maintain
their hospital listings. It is possible, however, that cost containment pressures
may prompt many hospitals to include only two lower-priced branded- generic
versions of a given molecule on their formularies, a move that would be
harmful to MNPs.

To mitigate this risk and maximize the likelihood that their drugs remain on
hospital formularies, MNPs will need to become more vigilant about managing
their relationships with hospitals. They should therefore revisit their efforts
on education, not just for physicians but also for the other participants in the
decision-making process (e.g., pharmacists). It may also make sense for these
companies to explore broader partnerships with hospitals (e.g., by sponsoring
hospital-based screening programs or patient-access programs) so that they
can establish the value proposition for their drugs and differentiate them from
the other brands or molecules competing for formulary approval.

Tendering/bidding
Getting a drug on the RDL and on hospital formularies is not sufficient for
gaining market access in China. The drug must also be stocked in pharmacies
– particularly hospital pharmacies, which dispense over 85 percent of all
prescription drugs sold in China. Provincial and city tenders are playing an
increasingly large role in the procurement process for the hospital pharmacies
in their regions.

If a company’s bid in response to a tender is not accepted, its drug is usually

subject to tight volume controls. MNPs may therefore be tempted to bid
low on some tenders to ensure market access, but this approach can have
unexpected consequences. Many Chinese provinces are starting to use
reference pricing, and so the outcome of a tender in one province can have
cascading effects in other parts of the country. We therefore recommend
that MNPs think strategically about the tendering/bidding process and then
develop appropriate tactics to ensure that they can balance the need for
market access against the need for effective pricing.
 13

Doing so may be difficult for MNPs initially, because the tendering/bidding

process is convoluted and opaque, and often seems like a black box to anyone
not directly involved in it. Given the growing importance of provincial and city
tenders, however, it is necessary that MNPs develop the ability to assess each
tender individually to determine the right price to bid. Equally importantly, the
companies must have clear guidelines for when it is appropriate to walk away
from a tender.

Successfully navigating the tendering/bidding process requires a cross-

functional effort with involvement from sales, commercial (with the support
of distributors), and the government affairs team. The marketing department
is also often involved to help prepare the detailed product information that is
required in certain tenders to justify the product’s inclusion.

In particular, MNPs should make sure that their government affairs organizations
have the resources available to understand the dynamics within each province
and city. For example, some provinces and cities are much more concerned
with cost containment than others are. The provinces and cities also vary
considerably in the extent to which they are influenced by local pharmaceutical
companies (particularly if those companies have headquarters or manufacturing
facilities in the area). We have repeatedly seen that MNPs that submit a bid
without a clear sense of those dynamics are rarely successful in getting the
pricing they want.

Finally, every MNP should invest in a well-designed stakeholder management

plan at the provincial and city level. The plan should help a company
communicate the value of its drugs and the investment it is making in
improving the quality of and access to care in China.
 Sales-Force expansion
and management
14

Although the pharmaceutical industry has ended its long “arms race” in
the U.S., it appears that China has become the new battleground for the
industry’s field forces. Between 2003 and 2007, the top 12 MNPs added an
estimated 8,000 sales reps in China, and their combined number now totals
over 12,000. For many leading companies, China will soon have the second-
highest number of sales reps after the U.S. At most MNPs, the return (in
terms of increased sales) is directly proportional to the number of FTEs added
(Exhibit 6). We have calculated, however, that the top MNPs will collectively
need to hire an additional 12,000 to 18,000 reps in China between now and
2012 if they are to meet their stated growth aspirations (Exhibit 7).

These companies must scale up their sales forces so that they go deeper
and expand more broadly in the China market. Most leading MNPs have
plans to detail a greater number of physicians within the hospitals they are
already targeting – they want to reach more junior physicians within currently
targeted departments and expand the number of departments visited in a
given hospital. Furthermore, most of these companies still have a lot of ground
to cover in terms of both new hospitals in currently targeted cities and new
cities with attractive market potential. Even the biggest MNPs have largely
concentrated their sales forces in China’s leading class III hospitals and its
top 100 cities3. But footprint expansion is becoming increasingly important for
them as the country’s economy grows, insurance coverage increases, and the
government intensifies its efforts to encourage patients to be treated in class
I and II hospitals and community health centers.

Finding a sufficient number of high-quality reps to hire will be a daunting task,

however. In comparison with 10 years ago, it is now much more difficult to
recruit graduates from leading medical schools or to hire doctors from big
hospitals. Furthermore, hiring salespeople away from local pharmaceutical
companies presents risks: The local companies often use “push” models that
incentivize physicians financially to prescribe their drugs, and getting these
reps to adopt a sales model based on the scientific evidence for a drug can be
difficult. Furthermore, the local companies are also in great need of additional
sales reps, and many of them are trying to transition to a more scientific
business model; thus, they will increasingly be competing with the MNPs for
the same talent pool.

3 China’s hospitals are categorized into three classes, largely based on hardware. Hospital
class does, however, correlate roughly with hospital size in that the best (class III) hospitals
tend to be large.
 15

Exhibit 6

Companies that have increased FTEs most rapidly have driven the
most growth

Fold increase in sales 2002-07

5.5
MNC 3
5.0
MNC 1
4.5

4.0 MNC 2

3.5

3.0 MNC 6
MNC 4
2.5 MNC 8 MNC 7

2.0 MNC 5

1.5

1.0
1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5
Fold increase in sales FTE 2002-07

Source: Industry and IMS sales data; field interviews; McKinsey analysis

Exhibit 7

Significant field force expansion expected to support ESTIMATE

high growth aspirations

High growth aspirations ... ... imply significant field force ramp-up

Cumulative revenue of top 12 MNPs* Incremental sales reps needed

US$ billions**
• At current productivity levels*** ᱷ18,000
8.6
• Assuming 25 percent increase
in productivity from current
levels ᱷ12,000
~20%
CAGR
~32% • 1,000-1,500 new reps by company
CAGR
3.5 • Compounded by high industry turnover
of ᱷ24%
2.0
• Gains in productivity imperative to
sustain model

2005 2007 2012

* Prescription drugs only; ex-manufacturer value

** Assumes constant exchange rate over the period
*** Current average productivity of US$290,000 per rep
Source: McKinsey analysis
16

China’s high employee turnover rates exacerbate the need for additional reps.
In the aggregate, MNPs have a 24 percent annual turnover rate here; even
the best companies have a 15 percent rate. As a result, the average MNP
sales rep has only two years’ experience in the job, and most companies
must change rep assignments frequently, making it difficult for the reps to
build strong relationships with doctors. At some MNPs, nearly 40 percent of
physician-rep assignments are changed each year.

The operational implications of sales-force growth are equally daunting.

Within a few years, the MNPs competing for market leadership in China will
be managing field forces with more than 3,000 reps, covering thousands of
hospitals in hundreds of cities over a vast geography.

Given these realities, what should MNPs that want to succeed in China do? To
answer this question, the companies must consider two related issues: how
they can maximize the return on their sales-force investments, and how they
can differentiate themselves in the market. There are four areas outside the
day-to-day realities of sales-force management that MNPs can explore:

Recruiting/training. The employee attrition rate in China is unlikely to

dramatically improve, given the talent situation. Therefore, MNPs should
invest in developing recruiting and training engines that are sized for the
market’s scale and complexity. To succeed, these companies must be able
to recruit and train a large number of reps and managers every year, so they
need a streamlined approach for identifying, cultivating, and instructing new
employees. Some MNPs have recognized this need and have adopted new
approaches. For example, a few companies have created formal “sales-force
universities” that can help meet their exploding training needs. MNPs must
go further, however. They must expand the profile they typically use to identify
candidates for rep and manager positions – just tapping the same pool for
additional reps is becoming increasingly untenable.

Productivity. In the recent past, given the country’s very fast growth rates,
many companies have paid scant attention to how they could improve sales
productivity. However, MNPs must crack the code of sales-force productivity
in China. They must start thinking more deeply about hospital and physician
segmentation, the effectiveness of all calls/details, and how they can better
align their resources against market potential. Although most MNPs have
 17

global sales-force-excellence initiatives, the initiatives usually have to be

simplified and tailored for implementation in China, for several reasons. As we
mentioned, companies in China often lack the types of detailed data required
to implement the sophisticated segmentation approaches that work in more
developed markets. And because the average tenure of most reps in China is
so low, they lack the skills needed to utilize complex segmentation approaches
in the field. In addition, the Chinese market is highly tiered, and there are
significant variations across cities and across hospitals within cities.

Value proposition. MNPs should develop a better value proposition for their
sales reps, and in particular for their front-line sales managers. Given
China’s scale, the front-line managers must be the glue that holds the sales
organization together. At present, most MNPs have simply copied the value
proposition they used globally, which is primarily based on compensation.
Successful employers in China are beginning to offer rewards that go beyond
compensation to retain their best people; these rewards can include more
regional/global exposure, executive education, and other indirect financial and
career-building incentives.

Alternative models/approaches. MNPs should continue to explore alternative

sales-force models and approaches. China’s size offers companies a large
canvas for innovation and ample opportunity to experiment. MNPs should put
in place methods for systematically piloting new ideas, such as the use of a
phone-based sales force for lower-tier cities or part-time reps for lower-class
hospitals.

In China, the competition for talent affects all industries, not just pharmaceuticals
– and all business functions, not just sales. But given the size of MNP field
forces, finding and retaining sales reps – and maximizing the productivity of
the sales force – will be top of mind for general managers for years to come.
 Distribution and retail channel
management
18

Even the best field force will be ineffective if a company cannot get its drugs
to hospitals and pharmacies, and distribution remains a significant challenge
in China. Thus, MNPs must develop both short- and long-term strategies for
working with drug distributors. Furthermore, they must not ignore the retail
pharmacy channel. Although this channel accounts for less than 15 percent of
all prescription drug sales in China, it presents specific opportunities, as well
as several risks that must be managed carefully.

Drug distributors
In China, drug distribution is highly fragmented. There are more than 10,000
distributors, and the top 10 companies combined have only a 34 percent
market share. The vast majority of distributors operate in only one or a few
cities; they rely on their relationships with local hospitals for sales. As a result,
the supply chain is convoluted; drugs may pass through multiple hands before
reaching hospitals and pharmacies (Exhibit 8). For this reason, many senior
pharmaceutical executives in China view their supply chain as another black
hole – they may know who their level 1 and 2 drug distributors4 are, but they
have little insight into what happens to their products beyond that.

Exhibit 8

Multi-tier, fragmented distribution system

Manufacturers

Level 1 distributors
(e.g., SinoPharm, Shanghai Pharma)

~10,000
Level 2 distributors
distributors

Level 3 distributors

• ~20,000 Retail
hospitals Hospitals
pharmacies
• 200,000
Class Class Class Community Inde-
+ retail Chain
pharmacies III II I health centers pendent

Source: SFDA; MoH: Interviews; McKinsey analysis

 19

Fortunately, there are some signs that the industry is consolidating, although
the speed of change is slow (Exhibit 9). For example, several leading
companies are building regional coverage through mergers and acquisitions5.
Furthermore, a number of small distributors have exited the market because
of accounts receivable problems, difficulties in obtaining GSP (good supply
practice) certification, and the repeated price cuts that have squeezed – and
in some cases eliminated – their margins.

Exhibit 9

There are signs of gradual distributor consolidation

Market share of distributors*

Top 10
distributors 26 26 31 34

Top 11-100
distributors 33 36
36 34

Others 41 38 32 32

2001 2003 2005 2007

Number of distributors
~16,000 ~10,000

* Total revenue of all distribution companies, including wholesale and retail, based on ex-trade prices
Source: China Association of Pharmaceutical Commerce; National Development and Reform Commission Office;
McKinsey analysis

In the short term, MNPs should accept the fact that they must have sizable
distribution networks if they want to pursue broad geographic coverage. We
recommend that MNPs begin by selecting 10 to 30 Level 1 distributors to
work with. Among the factors that should be evaluated are each company’s
scale, network, geographic coverage, logistical capabilities, hospital access,

4 China’s drug distributors are grouped into three levels. Companies in the first level have
national or regional distribution capabilities. Often, however, they must subcontract work
out to smaller companies to ensure that they can distribute drugs to smaller or more
remote cities. Level 2 distributors have narrower capabilities, although they can often reach
multiple cities. Level 3 distributors (the majority of companies) have very limited distribution
capabilities, often restricted to no more than a few cities.
5 For example, Sinopharm has started to build regional coverage in Guangdong province through
its acquisition of Accord Pharmaceutical Co.
20

and creditworthiness. If MNPs want to supply drugs to smaller hospitals and

more remote cities, they will also need to work with a large number (typically,
100 to 1,000) of level 2 and 3 distributors.

Of course, MNPs must have strong distributor management capabilities to

cope with such a sizable network effectively and ensure channel transparency
and stability. Many of them will have to develop systems, processes, and
in-house resources to collect drug sales data from as many distributors as
possible in a timely and accurate manner. But even if they are successful
in doing this, they must accept that in the short term it may not always be
possible to match the sales volume sold to distributors with the volumes
reported from end customers.

However, MNPs can derive benefits (beyond logistics) from this large network
by leveraging the value-added services distributors can offer. With their local
contacts and resources, for example, distributors can serve as valuable
partners to MNPs by providing assistance with the drug tendering and hospital
listing processes, as well as important business intelligence about the
markets they serve.

Over a longer time frame, MNPs may be able to leverage certain of their
distributors to penetrate some of China’s wealthier lower-tier cities6 and rural
areas. Many companies see these cities and areas as a long-term opportunity,
particularly for their mature products and inexpensive therapies, but they
currently have no way to exploit it cost effectively. MNPs should remember,
however, that they cannot simply outsource the sales effort for prescription
drugs to distributors. A crucial part of generating demand is building doctors’
knowledge about them, and few distributors have the capabilities to provide
scientific information to doctors. An MNP could solve this problem by
collaborating with a few distributors that are both credible and interested in
expanding. For example, the MNP and its qualified distributors could adopt
the “shadow management” approach widely used in the fast-moving consumer
goods industry. Under this approach, the MNP would provide support as
the distributors set up sales teams to promote drugs. The MNP would offer
training and incentives to the distributors’ salespeople, and it would also
closely manage their daily work.

6 Per McKinsey definition, China has four city tiers. Classification is based on wealth (disposable
income per capita) and scale (population) of each city.
 21

Retail pharmacies
At present, total retail pharmacy sales in China are estimated to be about
US$16 billion; over-the-counter medications and traditional Chinese medicine
account for more than 70 percent of this spending. Less than 15 percent of
total prescription drug sales are sold through the retail pharmacy channel,
and this is unlikely to change significantly in the near term (Exhibit 10).
Chinese hospitals derive a significant portion of their income and profit from
their pharmacies, and so the separation of drug prescribing and dispensing is
unlikely to happen unless significant changes are made to the funding model
for hospitals. Furthermore, China’s new community health centers, which
are being set up rapidly and which provide convenient access to prescription
refills, pose increasing competition to retail pharmacies.
Exhibit 10

China retail pharmacy sales are estimated at US$16 billion, but retail
remains a small channel for Rx drugs

Retail pharmacy sales*

(US$ billons᷊

This represents
16.2 <15% of total
Rx sales
+17% 13.5 20% Rx

11.6
10.0
8.8 40% OTC
7.5

30% TCM

Non-medical
10% merchandise
2002 03 04 05 06 2007
* At retail price
Source:China Southern Medicine Institute of Economics; interviews; literature search; team analysis
22

Nevertheless, MNPs should not ignore the retail pharmacy channel, for at least
three reasons. First, the importance of this channel to a specific prescription
drug can vary widely, depending on the product’s pricing, indication, and life-
cycle stage. For example, up to 30 percent of the revenue for some mature
brands can come from retail pharmacies. Also, there is large geographic
variation; the retail channel presents a fairly significant share of prescription
drug sales in some Chinese cities, such as Harbin. Second, the risk of
product stock-outs and generic substitution at retail pharmacies is high. A
new government policy mandates that prescriptions be written with only a
drug’s chemical name, which makes it easier for pharmacies to substitute
generic versions. Third, prices at retail pharmacies, which are typically lower
than those charged by hospital pharmacies, are sometimes used as reference
prices by the provinces and cities; price erosion can be significant unless retail
channel prices are managed carefully.

MNPs can take steps to strengthen their retail channel management skills
and thereby capture the opportunities for certain products/geographies and
minimize the downside risks. For example, they can establish a key account
management team to work with China’s top retail pharmacy chains; this will
help ensure that they have broad coverage for their drugs, that no stock-outs
occur, and that pricing levels are maintained. In addition, they can provide
training to pharmacists at key stores to reduce the likelihood of generic
substitution.

Given the challenges we have outlined, drug distribution may be the core
capability that takes the longest for MNPs in China to master. But it is crucial
for their long-term success in China.

*****

To win in China, MNPs must have both a solid strategy to drive growth and
the core capabilities to execute against that strategy. These capabilities
include the ability to develop deep market insights, to ensure broad market
access, to drive productivity from an expanding sales force, and to establish
reliable channels for drug distribution. Our experience has convinced us that
strong execution will be the biggest factor determining which MNPs do best
in China.
 23

Contributers

Franck Le Deu is a Principal in the Shanghai office

Franck_Le_Deu@mckinsey.com

Rajesh Parekh is a Principal in the Shanghai office

Rajesh_Parekh@mckinsey.com

Jin Wang is an Associate Principal in the Shanghai office

Jin_Wang@mckinsey.com
October 2008
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