pharmasia summit2013 report "in search of new growth models for big pharma in china"

THE PHARMASIA SUMMIT REPORT – CHINA 2013:

In Search Of New Growth Models For Big Pharma In China

Lead Writers: Gaobo Zhou, Tina Hou, Daniel Liu and Li Ma, McKinsey & Company

Editor: Dai Jialing, PharmAsia News, Elsevier Business Intelligence

Managing Editor: Tamra Sami, PharmAsia News, Elsevier Business Intelligence

Project Manager: Kim Gordon, Elsevier Business Intelligence

Design: Gayle Rembold Furbert and Jean Marie Smith, Elsevier Business Intelligence

Strategic Oversight: Franck Le Deu, McKinsey & Company; Jimmy Zhang, PhD, MBA, BayHelix; Steve Yang, PhD, BayHelix; Joshua Berlin, Elsevier Business Intelligence

For questions or comments about this report, please contact:Joshua Berlin, Head of Emerging Markets, Elsevier Business Intelligence, at [email protected].

ACKNOWLEDGEMENTS:

copyright© 2013 Elsevier Business Intelligence

OCTOBER 2013 3In Search Of New Growth Models For Big Pharma In China

INSIDE:

Introduction

Executive Summary

Overview Of Market Trends

The Cost Containment Drive

The Innovation Imperative

Implications And Path ForwardFor Sustainable Growth

Conclusion

Appendix I - Glossary

Appendix II - PharmAsia Summit Survey Results

About Us

PharmAsia News Free Trial Offer

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45

45

68

4140

69


China represents an enormous opportunity for the pharmaceutical industry given unmet medical needs, demographic changes (e.g., an aging population, adoption of Western lifestyles) and government support, including China’s health care reform, which has extended basic medical insurance to virtually all of the country’s 1.3 billion citizens.

At the same time, affordability barriers, complicated and lengthy regulatory and reimbursement pathways and a recent drive to improve compliance present unique challenges to multinational and domestic companies alike. In addition, China is changing. From faster growth in smaller cities to potentially more severe pricing pressure on off-patent medications, tradi-tional business models are challenged and new strategies are required to succeed and maintain growth.

While support for biopharma innovation is a major government goal, so is curbing health care cost. How can pharma companies collaborate and thrive in this environment? To gain a better understanding, Elsevier Business Intelligence and BayHelix, organizers of the PharmAsia Summit, worked with McKinsey & Company, Knowledge Partner to the Summit, to survey and interview industry executives on new R&D and commercial models for China.

Presented in this report are fi ndings from our study, and analysis that indi-cates transformation in China is likely to disrupt current business models.

We hope these insights can be of help as you formulate strategies for China in 2013 and beyond.

Introduction:

Joshua Berlin

Head of Emerging MarketsElsevier Business Intelligence

Jimmy Zhang, PhD

ChairmanBayHelix Group

Steve Yang, PhD

ChairmanPharmAsia Summit

Organizing Committee

Franck Le Deu

PartnerMcKinsey & Company

OCTOBER 2013 5In Search of New Growth Models for Big Pharma in China

What a difference a year has made…Since the release of the McKinsey & Company report, “Healthcare in China – Entering Uncharted Waters,1” just 12 months ago, the fol-lowing events took place: The Ministry of Health (MoH) became the National Health and Family Planning Commission (NHFPC) and changed leadership. The State FDA (SFDA) was given more authority and renamed as China FDA (CFDA). The government moved forward with the deepening of the health care reform, with an updated Essential Drugs List (EDL) that added many molecules important to multinational pharmaceutical companies (MNCs).2 In addition, 2013 is the fi rst full year that the new government led by Xi Jingping and Li Keqiang is establishing its priorities and policies. While there are expectations that the party leaders may use the party congress in November to align and roll out new macro level policies, we have already seen some broad stroke initiatives (such as the establish-ment of a free trade zone in Shanghai).

Importantly, China’s pharmaceuticals market grew by another 20%, to reach $70 billion in 2013 at ex-manufacturer price, with some sub-segments (e.g., oncology) or channels (e.g., county hospitals, Tier 3 cities) expanding at a much faster pace. A few MNC drugs approached the $500 million mark in revenue, highlighting that before too long the largest MNC drug in China could achieve the famed blockbuster status of $1 billion.

In addition, several high-profi le transactions took place such as a joint venture between Amgen Inc. and BetaPharma Inc.3 and a deepening of the relationship between Simcere Pharmaceutical Group and Bristol-Myers Squibb Co.4, while another venture between Pfi zer and Zhejiang Hisun Pharmaceutical Co. Ltd. moved to operational status. MNCs doubled down on innovation, with direct investments in R&D facilities, but also with more creative development partnerships to bring drugs to market such as those seen between Ascletis Inc. and Roche, and AstraZeneca PLC’s MedImmune division and WuXi PharmaTech Inc.5

Early signs of Chinese innovation were visible, for example with the global co-development and commercialization collaboration between BeiGene Co. Ltd. and Merck KGaA for an internally developed, second-generation BRAF inhibitor called BeiGene-283.6

Finally, compliance has taken center stage, as the government has launched a wide-rang-ing probe impacting MNCs, local pharma companies and health care providers.7

Executive Summary:

1 “Healthcare in China – Entering Uncharted Waters” available at McKinseychina.com.2 For defi nitions of key China acronyms/terms used in this report, see our Glossary of Terms in Appendix I.3 “To Jump Start China, Think Commercial: Amgen Ties Knot With Beta Pharma For Vectibix,” PharmAsia News, May 10, 2013. 4 “Three Times The Charm? BMS Ties Up With Simcere To Commercialize Orencia SC In China,” PharmAsia News, June 14, 2013.5 ”B-Harmony: WuXi And MedImmune Establish JV To Seize Biologics Growth In China,” PharmAsia News, Sept. 11, 2012.6 “Surge In Partnerships And Licensing In China Highlights Need For Greater Flexibility,” PharmAsia News, June 19, 2013.7 “Putting GSK’s China Bribery Crisis In Context,” PharmAsia News, July 18, 2013.

OCTOBER 2013 6In Search of New Growth Models for Big Pharma in China

In this seemingly constant fl ow of both positive and challenging market developments, it is helpful to step back to look at the big picture. The contrast is striking. On one hand, China offers a huge untreated population, clear commitment by the government to address health care as a social and economic priority, the promise of a more consumer-oriented economy, and signifi cant investments by multinationals across the value chain, leading to visible returns. On the other hand, the day-to-day reality of China reveals frustrating market-access conditions, rising pricing pressure and cost-containment measures that put a signifi cant share of MNC portfolios at risk, increasing local protectionism, and underlying compliance risks now visible to everyone.

In this report, developed in the context of the 2nd edition of the PharmAsia Summit Shanghai, organized by BayHelix and Elsevier Business Intelligence, with McKinsey & Company as Knowledge Partner, we summarize some perspectives on key trends impact-ing the market as well as their implications for MNC participants.

We do not seek to provide answers to all questions. Rather, we provide a temperature check, refl ecting insights from a survey of 50 industry leaders based in China, as well as our own perspectives.

A s part of the effort to prepare this report, McKinsey launched a targeted survey of senior pharmaceutical industry executives. In total, more than 50 executives re-sponded to the survey, ranging from regional leaders, country general managers,

VPs and directors across commercial, medical and R&D functions.

The survey was designed to gather perspectives on a range of topics covering trends in the Chinese health care market and strategic moves to tackle challenges and capture opportu-nities. The survey was conducted before news broke about China’s anti-corruption probe.

Specifi cally, the survey was structured around four topics:

• Overview of market trends and their infl uence on industry decisions;

• Perspectives on China’s increasingly cost conscious market-access environment;

• Perspectives on China’s push for innovation and the R&D environment; and

• Strategic implications on what it takes to win.

About The PharmAsia Summit Industry Leader Survey:


SECTION 1: OVERVIEW OF MARKET TRENDS China’s pharmaceutical market has been on a great run, growing at 21% CAGR over the past fi ve years. In a recent joint forecast developed by McKinsey and the China Pharmaceutical Association (CPA), the China pharmaceutical market is projected to continue growing around 17% annually through 2020, approaching RMB 1.9 trillion in retail sales (~RMB 1.2 trillion in ex-manufacturer sales) (Exhibit 1). Sang Guowei, chairman of CPA, recently commented that “China’s pharmaceutical market is projected to surpass the U.S. as the largest in the world post-2020.”8 Regardless of the fi nal number, most experts agree that China will become the second-largest pharmaceutical market by 2020, and ultimately the largest one in the world.

In Search Of New Growth Models For Big Pharma In China

8 Keynote speech by Sang Guowei during the 15th Annual Meeting of the China Association of Science and Technology, May 25, 2013.

Exhibit 12020 CHINA PHARMACEUTICAL MARKET FORECAST

SOURCE: CPA; McKinsey analysis

0.5

0.8

1.6

Retail

Grassroots medical institutions

Hospital

2020

1.9

2015

1.0

2012

0.6

Base-case scenario

China’s pharmaceutical market forecast, retail price (base case)

RMB Trillion

CAGR 2012-2020

High-growth scenario

Low-growth scenario

6%

10%

15%

0.1

0.1

0.20.10.1

<0.1

11%

12%

17%

14%

14%

18%


This growth has been driven in large part by a fast-growing patient population that now has ac-cess to basic government health insurance. For example, the breast cancer incidence rate per 100,000 urban female residents grew from 36 to 519 between 1998-2007, childhood asthma patients grew from 1.1% in 1990 to 3.0% in 2010,10 and Alzheimer’s disease patients in-creased from about 3.8 million in 2000 to 5.6 million in 2010.11 While some of the growth can be attributed to improved disease tracking, other more fundamental growth drivers, such as an aging population, adoption of western lifestyles, environmental factors and related causes have contributed to growth in disease prevalence. Diseases also have been undertreated in the past and experienced visible improvements in treatment rates in recent years. For example, of the 200 million people with hypertension, 25% were managed in 2002, with rates rising

9 Chinese Journal of Preventive Medicine, 2012 Aug; 46: 703-7.10 China Journal of Pediatrics, 2003 Feb; 41(2): 123-7 and result announcements from the 3rd nation-wide survey on prevalence of asthma in urban children (Prof. Chen, Yuzhi).11 Lancet, 2013 June; 381: 2016-23.

W e recently developed an integrated forecast for the China pharmaceutical mar-ket, in partnership with CPA. Our forecast of the China pharmaceutical market was conducted across three segments: hospitals, grassroots facilities, and retail.

We built an integrated market model linked to underlying drivers of the market at geographic and segment levels, including patient fl ow, spend per capita, pricing and drug usage trends, etc.

• Hospital: Segmented into 15 sub-markets by city tier (1/2/3/4/county) and hos-pital Class (III, II, I). The hospital segment is expected to remain the largest segment till 2020 with a 17% growth rate, compared with 22% CAGR from 2008-2012. Due to Basic Medical Insurance (BMI) budget control, the growth rate of the hos-pital market in Tier 1 and 2 cities is expected to slow down to 12% and 16% respectively, compared with 17% and 24% from 2008-2012. The tier 3, 4 and county market will maintain strong growth momentum at 18%+ CAGR through 2020. Class III hospitals will continue to outgrow the overall hospital segment and account for 70% of the hospital market by 2020. Class I hospitals, including private hospitals, will also grow at a healthy 18% CAGR driven by recent govern-ment policy support for the private hospital sector.

• Grassroots facilities: Segmented into Community Health Centers (CHC) and Town-ship Health Centers (THC). CHCs are expected to maintain historical growth mo-mentum at 19% CAGR, driven by continued government investment and increasing treatment of chronic disease under CHC management. Growth trajectory of THCs will decrease slightly from 4% in 2008-2012 to barely 1% in the next few years.

• Retail: Expected to maintain 12% growth from 2012-2020. The channel shift from the hospital market to the retail segment is not expected to happen until hospital funding reform achieves real impact.

McKinsey/CPA China Pharmaceutical Market Forecast Methodology:


to 33% in 2013. Similarly, the number of patients with end-stage renal disease on dialysis increased from 70,000 in 2007 to 200,000 in 2011.

Treatment options have also expanded with improved patient access to targeted therapies and biologics. For example, between 2010 and 2012, the proportion of rheumatoid arthritis patients treated with biologics doubled from roughly 3.5% to about 7%, and HER2 testing for breast cancer patients increased from 65% to 75% from 2010-2012. In addition, patients in lower-tier markets signifi cantly improved their access to health care, creating corresponding growth segments that are expected to fuel market expansion in the medium term. Similarly, pharmaceutical sales growth in tier 2/3 cities have outpaced the market, driving their share of the total market from ~55% to ~60% in just four years (Exhibit 2).12

MNCs have benefi ted from this impressive growth demand with a signifi cant change in the scale of their operations in China (Exhibit 3). China is playing an increasingly important role to the global business of MNCs. On average, China sales of the top 10 MNC pharmacos ac-counted for 3.8% of their global business in 2012, up from 3.0% just a year earlier (Exhibit 4).

12 For further evidence of the pace of development of the market, refer to the McKinsey-CPA report (included on the PharmAsia Summit fl ash drive), July 2013 edition, which provides a detailed analysis of the development of the oncology market in a sample of leading hospitals.

Exhibit 2KEY DRIVERS OF CHINA PHARMA MARKET GROWTH

SOURCE: McKinsey PharmAsia Summit Survey

20%

20%

12%

16%

8%

6: Very significant 7: Most significant

6%

Trends related to demand growth are key drivers of market growth

Significance of key trends in driving near term pharma market growth(1- not significant at all, 7- most significant)

Trends Distribution of scores 6 and 7

Shifting demographics and growing disease prevalence

Disease awareness and improving diagnostics

Improving insurance coverage

Improving health infrastructure and access in lower-tier markets

Favorable policy support to innovation

Rise of local innovation

Improving innovation infrastructure and R&D talent pool

34% 46%

48%

30%

38%

28%

22%

20%


For some companies, Novo Nordisk AS for example, the fi gure is already much higher, and for many others China is now a key contributor to absolute value growth in global revenues, a trend facilitated by ongoing pricing pressure in Europe and the U.S., as well as patent cliffs at many companies. In our survey of pharma industry leaders, more than 90% said China is already a top fi ve global strategic priority and 65% said it would be among the company’s top three global strategic priorities in fi ve years.

With the rise of China’s importance for global pharmaceutical companies, change is also taking place as the industry faces headwinds from government policies and pilot programs aimed at controlling the cost burden to the health system. In our survey, industry leaders high-lighted the three most important factors that could hinder industry growth as:

1) Lack of or delayed reimbursement for innovative drugs (two to fi ve years for drugs to be listed post-launch);

Exhibit 3FROM 2005 THROUGH 2012, THE SCALE OF COMMERCIAL PERFORMANCE IN CHINA INCREASED SIGNIFICANTLY

SOURCE: RDPAC; press search; McKinsey analysis

$

490

110

X4.8

2012 (Plavix)

2005 (Heptodin)

2.5

12.3

+9.8

2012 2005

11

2012

85

4400

3344

2005

8

662

0

Rev. > $200 mn Rev. $100 - 200 mn Rev. $50 - 100 mn

Exchange rate: USD:RMB=6.15

The top 10 pharma multinationals added close to $10 billion in sales in seven years

Cumulative sales of top ten pharma multinationals (prescription drugs only)USD billion

Eighty-five brands exceeded $50 million in sales compared with eight only seven years ago

Distribution of size of major prescription-drug brandNumber of brands

Annual salesUSD million

The largest prescription-drug brand is approaching $500 million in annual sales


2) Fragmented tenders and intensifying pricing pressure; and

3) Slow registration process for new products (average fi ve- to seven-year delay com-pared to international markets, with some exceptions and expectations that this gap will decrease).

To address the complexities associated with a market that increasingly emphasizes both cost control and drug innovation, pharmacos have begun to shift their strategies. The shift is driven largely by the shape of each company’s portfolio in China. For MNC pharmacos, on average 70-80% of their portfolios still consist of off-patent products that are particularly sensitive to cost-control measures (Exhibit 5 ).

In the past fi ve years, “expanding sales forces to increase coverage and deepen penetra-tion” and “introducing innovative products into China” have been the most important drivers for pharmaceutical companies’ growth. Moving forward, given intensifi ed cost pressure and push for innovation, executives see “introducing innovative products into China,” “strength-ening the organization,” (e.g., investing in a winning talent strategy and strengthening orga-nizational capabilities) and “exploring new commercial models” as most important to sustain growth momentum (Exhibit 6).

Exhibit 4CHINA INCREASINGLY IMPORTANT FOR THE GLOBAL PHARMACOS


3.3%

2.6%

MNC4

4.1%

2.8%

MNC3

5.7%

4.1%

MNC2

8.4%7.9%

MNC1

10.8%

8.8%

3.8%

3.0%

MNC10

1.9%2.0%

MNC9

2.0%1.6%

MNC8MNC5

2.7% 2.6%2.3%

MNC7

3.1%

2.4%

MNC6

3.2%

2011 2012

Percent

China Rx sales as a proportion of global Rx sales for the top 10 MNC pharmacos in China

Average of top 10


Exhibit 5MOST MNC PHARMACOS RELY HEAVILY ON NON-PATENTED PRODUCTS IN CHINA


70%

34%32%21%19%19%18%16%13%6%

MNC9

MNC8

MNC7

MNC6

MNC5

MNC4

MNC3

MNC2

MNC1

94%

MNC101 Products that never had patent protection in China or lost patent protection

RMB Mn, %

Non-patentedproducts1

Patentedproducts

China revenue contribution between patented and non-patented products, 2012

87% 84% 82% 81% 81% 79%68% 66%

30%

Exhibit 6INNOVATIVE PRODUCTS AND COMMERCIAL MODELS ARE INCREASINGLY RELEVANT IN COMPANY STRATEGIES, SALES FORCE EXPANSION BECOMING LESS IMPORTANT


3.8

4.1

4.7

5.0

5.1

5.3

5.4

5.5

5.7

6.5

3.9

3.9

4.3

4.3

6.1

5.0

4.3

5.2

5.0

5.8

Investing in a winning talent strategy

Introducing innovative products

Expand portfolio with local BD

Expand footprint with local BD

Entry into new product segments

Expanding sales force

Adopting new commercial models

Strengthen organization capabilities

Organization restructuring

Government partnerships

Change in rankingof significance

1

2

4

No change

1

5

1

1

1

1

Past five years Next five yearsStrategies to drive growth

Success factors in driving pharma company growth (average score)(1- not significant at all, 7- most significant)

Significant changein ranking or remain important


Exhibit 7FAST GROWING DIABETES EPIDEMIC

SOURCE: Press releases; McKinsey analysis

11.311.6

9.7

5.5

2.8

19941 U.S. 20114,5201062007- 08320002

Estimation of prevalence rate in China Percent

1

2

3

Recently released data indicate that prevalence of diabetes now exceeds that of the U.S.

1 National Diabetes survey, among aged 25-64, by WHO 1985 criteria (Pan, XR, et al, 1997).2 InterAsia survey, among aged 35-74, by American Diabetes Association (ADA) 1997 criteria (Gu, D, et al, 2003).3 China National Diabetes and Metabolic Disorders Study, among aged 20 above, by WHO 1999 criteria (Yang, WY, et al, 2010).4 Prevalence among >20 years old Chinese Americans is estimated at ~11.7%.5 Released by ADA in 2011.6 Released by JAMA in September 2013; prevalence in adult population (18 years old and above).

Significant, fast growing burden for the Chinese health care system, with ~114 million people with diabetes, and up to 490 million with pre-diabetes;

Market of critical importance for MNCs that have aspirations for global leadership in diabetes;

Need for China-focused R&D to better understand the disease in the Chinese population and to potentially develop tailored drugs.

In summary, we see a market that from a demand stand point will continue to expand at a fast pace and create very signifi cant opportunities for industry participants offering the right mix of products and services. This may be best illustrated by the recent upward revision of the estimate of diabetic and pre-diabetic populations in China. The latest study published on September 4, 2013, in the Journal of the American Medical Association, suggests that 114 million Chinese are diabetic, adding in one swoop roughly 20 million potential patients to treat to the burden of the government, and putting the prevalence rate at 11.6%, ahead of the U.S.’s rate (Exhibit 7 ). It is however a market that is becoming more diffi cult to navigate, not less, and where scale – for example breadth of portfolio and depth of capabilities – increas-ingly becomes a competitive advantage.


SECTION 2: THE COST CONTAINMENT DRIVEThe vision for the government’s health care reform, which kicked off in 2009, is clear and compelling – provide universal, quality access at low cost by 2020. What is not as clear though is whether the fi nancial implications of this bold commitment have been fully compre-hended by all stakeholders, particularly in the face of rapidly evolving epidemiologic trends.

While China has continuously achieved fast economic devel-opment during the past decade, it also faces a signifi cant increase of health care burden and a slowing economy, albeit at a still enviable annual rate of ~7.5%. On average, heath care spend has grown faster than economic growth in the last fi ve years. This gap between economic growth and health care growth is a positive trend given the low starting point, and it will likely persist for a period of time as the government ramps up access. The government has set the target for health care spending at 7-7.5% of GDP by 2020. Although this is a meaningful increase from China’s historical level, currently around 5.6%, it is still much lower than ratios prevailing in developed countries, such as 12% of GDP in France, and 18% of GDP for the U.S. Further, the per capita spending will remain low, even by 2020 (i.e., $710 versus $5,130 on average in Western Europe, and $12,237 in the U.S.) at projected value. This low target, in relative and absolute terms, implies the need for the Chinese government to fi nd innovative ways to provide care, to make trade-offs in budget allocations, and to signifi cantly improve the overall effi ciency of the health care system. This is all the more critical as China is still at an early stage of emergence of its health care burden, and decisions made in the next few years will have long lasting consequences.

Chronic diseases will be a major driver of the country’s health care burden, and treatment al-ready accounts for 68% of total health care spending.13 It should be no surprise then that Na-tional People’s Congress Vice Chairman, and former Minister of Health, Zhu Chen, referring to the progress of the health care reform, said,:14 “Facing old problems [huge population base, relatively under-developed basic health care infrastructure] and the new problems [explosion of chronic disease prevalence], we need to establish an effective and cost-effi cient health care system with universal access to the whole nation; otherwise, we will face an even heavier burden 10 years down the road due to the explosion of complications of chronic diseases.”

At the other end of the spectrum, Chinese patients still have very limited access today to the newest and most advanced therapies of MNCs, such as targeted therapies for cancer treatment or immune disorders. Patients rely on their ability to pay out-of-pocket and patient assistance programs (PAP) for access. Providing central or provincial government-funded re-imbursement on a broad basis for these drugs would have a signifi cant impact on budgets. Further, the government will likely need to take a more active role in rebalancing the fi nancial mechanisms of public hospitals, a source of many tensions.

Not surprisingly then, policies and industry practices are increasingly in place to implement “cost effective” elements of health care reform, and have been undertaken by various stake-holders in the market, including payers, providers, and regulators. The implementation of those measures, ranging from EDL expansion to diagnosis-related group (DRG) pilots, cost capitation and various drug-level containment measures, is moving at different speeds and with different models at the provincial level, infl uenced by local conditions. For example,

Chinese patients still have very limited access today to the newest and most advanced therapies of MNCs, such as targeted therapies for cancer or immune disorders.

13 “Toward a Healthy and Harmonious Life in China: Stemming the Rising Tide of Non-Communicable Diseases,” The World Bank, July 2011. 14 Speech at the China Hospital Development Forum in June 2013.


Shanghai’s local government has been at the forefront of cost-containment measures, react-ing to a defi cit in its BMI scheme. As a result, the growth of the pharma market in Shanghai slowed dramatically compared to the national average, despite higher income per capita, with signifi cantly higher generic substitution taking place.

Our survey of industry leaders shows that among the fi ve top factors preventing the industry from faster development, three relate to “cost containment,” including “fragmented tenders and intensifying pricing pressure,” “public hospital reform,” “EDL expansion and erosion of non-EDL market in large hospitals.”15 We will discuss the other two “delayed and lack of reimbursement for innovative drugs” and “slow registration process for innovative products” in the next chapter (Exhibit 8).

Intensifying pricing pressurePricing pressure has been intensifying during the past years, driven by multiple factors.

NDRC (retail) price cuts have affected some therapeutic areas almost every year over the past 15+ years, with each time impacting products’ retail prices by 10-20% (sometimes up to 30-40%) for off-patent products, and 5-10% for innovative products. Going forward, NDRC

Exhibit 8MARKET ACCESS AND PATIENT ACCESS HURDLES EXPECTED TO HINDER PHARMA MARKET GROWTH


Statistics of scores indicating the significance of each trend hindering growth(1- not significant at all, 7- most significant)

6: Very significant 7: Most significant

Trends that hinder growth Average scoreDistribution of scores

4%

46% 38%

44..88 Lack of effective commercial approach to sufficiently serve broad market

Growing competition from cheap alternative drugs hindering adoption of innovative/quality products

55..00

EDL expansion and erosion of non-EDL market in large hospitals

55..00

Public hospital reform (e.g., Zero markup, DRG, total budget control) 55..66

Slow registration process for innovative products 55..99

66..00 Fragmented tender and intensifying pricing pressure

66..00 Delayed and lack of reimbursement for innovative drugs

cost containment factors

26%

24%

44%

38%

24%

30%

48%

46%

24%

16%

20%

15 “In China, A Province’s Drastic Price Cut Model Is Being Modifi ed To Fit A Nationwide System: A Look At The Anhui Model,” Pharmasia News, April 7, 2011.


price cuts are expected to continue and bring down products’ retail prices, probably with more focus on controlling prices of off-patent originator drugs.

Tendering is another key factor intensifying pricing pressure for manufacturers. Since Anhui prov-ince’s “double-envelope” model for EDL tenders fi rst emerged in 2010, several other provinces followed suit and fi erce pricing erosion started, especially for generic products with multiple manufacturers. This resulted in unsustainable profi tability for manufacturers, especially local ones. This price-driven tendering model also threatened product quality and led to supply shortages for some low-priced products in certain provinces. To correct this situation, the State Council issued a notice in March 2012 to focus on quality fi rst in tenders rather than price alone.

Going forward, we expect to see more “quality” elements incorporated into the tendering pro-cess to lessen pricing pressure. For example, Jiangsu province has separate evaluations based on quality categories, while Shanghai adopted a model that awards a higher overall score based on 63% for quality, 7% for reputation and service and 30% for price. More remarkably, Anhui unveiled its county hospital tender in 2012 using separate evaluations for different qual-ity categories and applying 60% for quality in the overall score. Leading local companies and MNCs will benefi t from this trend of greater focus on quality, and will face less head-to-head competition from low-priced products.

Application of international reference pricing (IRP): In April 2012, NDRC requested MNCs to provide prices of their products in 10 markets and NDRC visited some of the 10 countries to learn about their pricing policies. Were IRP to be adopted in a way that directly compares prices with other countries, prices of MNC products, especially off-patent products, could see signifi cant cuts. However, implementation of IRP could still be years away, and modalities of implementation could mitigate the actual impact.

Application of reimbursement-based pricing: NDRC recently disclosed the intention to adopt reimbursement-based pricing as one measure to narrow the price difference between MNCs’ off-patent originators and local generics. With the defi ned reimbursement cap for one mol-ecule, any gap above the cap would be paid out-of-pocket. This approach, compared with the current “reimburse by percentage” method, will increase pricing pressure on MNCs, es-pecially if local generics pass bioequivalence testing, as required by the government by the end of 2015. We expect the government to start exploring this pricing approach, with pilots at small scale (both at geography and at product level) in the next year or two.16

Accelerating public hospital reformCurrently, public hospitals, which represent the vast majority (close to 90%) of health care ca-pacity, operate with insuffi cient direct subsidies from the government. As a result, physicians in China are paid much less than their Western peers, a source of tension for the system. In addition, hospitals are paid under a fee-for-service model, which incentivizes hospitals/physicians to potentially over-prescribe medical tests and drugs, and hospitals traditionally apply a markup of up to 15% at captive pharmacies so are also potentially incentivized to prescribe more expensive treatments.

Payment scheme reform has been identifi ed as the breakthrough point for public hospital reform and a key mechanism to better control health care costs. Since the new health care reform started in 2009, NDRC and MoH have begun pilots in 40 cities to explore different models. Since then, multiple models have emerged, including DRG, pioneered by Beijing; capitation, represented by grassroots institutes of Miyun and Pinggu counties in Beijing; total-

16 “China Drug Price Reform Takes Shape: Price Ceilings Out, Reimbursement Caps In,” PharmAsia News, Aug. 27, 2013.


Exhibit 9TOUGHEST CHALLENGE FROM REIMBURSEMENT POLICIES IN THE NEXT 5 YEARS

SOURCE: McKinsey PharmAsia Summit Survey result

Challenges # of votes (total votes in bold)

Long updating cycle for National Reimbursement Drug List

Reimbursement budget control policies

Lack of reimbursement for innovative drugs

Limited scale and slow development of private health insurance

Limited scale of implementation of catastrophic disease insurance

Top challenge

2nd toughest challenge

3rd toughest challenge

14

10

7

15

12

11

3

9

2 7

14

10

11

1

3413

37

2

38

2

Toughest

Easiest

Number of votes on the 1st, 2nd and 3rd toughest challenge from reimbursement policies in the next 5 years

budget-control, exemplifi ed by Shanghai and Zichang county in Shaanxi province; and a mixed model, such as in Zhenjiang in Jiangsu province. Despite these pilot programs, most experts believe the government will eventually need to increase funding for public hospitals if it wants to address the root cause of the current situation.

Despite the fact that payment scheme reform is still at an early stage, piloting initiatives have demonstrated signifi cant impact on the pharmaceuticals market. As discussed earlier, Shang-hai’s total budget control is a good example that has led to a slowdown of growth. Our survey also shows that industry leaders think “reimbursement budget control” poses the biggest chal-lenge to the industry among reimbursement policies in the next fi ve years (Exhibit 9). The fact that the Shanghai market’s volume growth did not change signifi cantly indicates substitution to lower-cost drugs. In hospitals with brand-specifi c controls, the negative impact on controlled brands could be signifi cant due to the high price of selected products.

2012 EDL expansion The Essential Drug System (EDS) is identifi ed as one of fi ve priorities to support the gov-ernment’s overall objective to establish a universal basic health care system providing safe, effective, convenient and low-cost health care services. The 2012 EDL expansion (released on March 15, 2013, but referred to as the 2012 EDL) is one step toward a stan-dard and comprehensive EDS targeted by the government for 2020.

Due to the potential impact (both positive and negative) that the EDS has on the industry, the 2012 expansion and its related policies have been actively debated by industry players. Al-though the 2009 EDL already created much discussion, in the end, with the notable exception of Merck Sharpe & Dohme (MSD)’s decision to pilot a broad EDL push with Zocor (simvastatin), MNCs overwhelmingly managed to contain any impact. This will likely change in the near term with the latest expansion of the list.


McKinsey/CMA Collaboration on Clinical-pathway Based Hospital Cost Analysis

A lthough experience has been gained through various pilot programs, payment scheme reform is far from

completed. Fundamentals, such as clini-cal pathways, hospital cost analysis and patient-treatment records, have to be in place to support more systematic reform. To establish one of those key stepping stones, McKinsey and the China Medical Association have formed a partnership on clinical pathways-based cost analysis on county hospitals (Exhibit 10). Results from the fi rst stage of the project on three diseas-es helped establish a cost-analysis model for future roll outs to other diseases and revealed limitations in the current pricing system of hospital services (Exhibit 11).

Activity based cost

PhysiciansBeds2CT+

MRIExamsNurses Medicine1 Consumables

4,545

6,106482

4963831,036

701

-26%

Hospital’s revenue

Hospital’scost

463

MedicineOther imaging

Consumables

2061,906

432

CT+MRI

ExamsNursesPhysicians

RMB Managementcost

Other imaging

7.4hours

# of activities 10.8day…25

hours … …… 10.8day…

94Cost per activity 1938342 1906 482496 43432

76 108 563 856 288 1906 554 45450194

-89% -90% 47% 72% -33% 0% 15% -26%-100%-6%

1 Including cost of pharmacy2 Including utility, maintenance cost3 Including out-of-pocket payment and payment from insurance

Direct cost from bed2

Man-agementcost

Rev. from patients3

Gaps btw. Rev. and cost

Areas where real cost is undervalued

Exhibit 11COST ANALYSIS ON CEREBRAL INFARCTION IN A COUNTY HOSPITAL IN SHAANXI DEMONSTRATES THAT HOSPITAL REVENUE IS LOWER THAN REAL COST

SOURCE: Hospital fi nancials; interviews with physicians and nurses; McKinsey analysis

Payment scheme reform

Clinical pathway-based cost analysis system

Clinical pathwayCost analysis methodology

Fundamental of payment

scheme reform Exploration of DRG model

Exhibit 10CLINICAL-PATHWAY BASED HOSPITAL COST ANALYSIS MODEL IS CRITICAL BASIS FOR PROGRESSING HOSPITAL PAYMENT SCHEME REFORM IN CHINA


Our survey shows that 62% of executives predict the impact to their business from the EDL will be mostly negative, and that volume upside will be offset by price pressure and will favor local companies. Thirty one percent believe the EDL will not have a signifi cant impact, and only 7% consider EDL expansion more of an opportunity than a challenge.

There are four major changes in the 2012 version of the EDL:

• Signifi cant increase of the range of the list and exposure for MNCs: EDL cover-age increased from 307 molecules to 520 (for Western drugs the EDL expand-ed from 205 to 317, and for traditional Chinese medicines (TCM) it expanded from 102 to 203), with broader disease coverage, including cancer, blood diseases and psychiatric disorders, and broader patient group coverage, such as drugs for women and children. Among 520+ products of R&D-based Pharmaceutical Association Committee (RDPAC) member companies, the number of products on the EDL more than doubled, from 56 to 126, represent-ing 30% of total current revenue after expansion. Ten of the top 50 products of RDPAC member companies were newly added to the list. Examples include top off-patent products like Sanofi ’s Plavix (clopidogrel), Novo Nordisk’s Novolin (human recombinant insulin), Bayer AG’s Glucobay (acarbose) and Pfi zer Inc.’s Norvasc (amlodipine). Companies with the highest exposure will have up to 60% of their revenues directly or indirectly impacted by the EDL (Exhibit 12).

• Broader implementation: The central government mandates broader EDL usage not only in grassroots institutes, but also in Class III and Class II hospitals, which are the core market of leading industry players. The EDL market will increase, but

Exhibit 122012 EDL INCLUDES SIGNIFICANTLY MORE MNC PRODUCTS


Average 30%

100% =

MNC 15

2.3

MNC 14

1.6

MNC 13

6.7

MNC 12

7.6

MNC 11

3.5

MNC 10

12.0

MNC 9

5.7

MNC 7

9.5

MNC 6

7.0

MNC 5

3.1

MNC 4

2.7

MNC 3

7.7

MNC 2

9.8

MNC 1

2.6 6.4

MNC 8

1 Rx only.2 Theoretical EDL exposure, including revenue from all dosage forms of the molecules listed on EDL

Revenue1 exposed to EDL2

RMB billion 2012 EDL 2009 EDL Not on EDL

.


at the same time, the Reimbursement Drug List (RDL) market in large hospitals may be negatively impacted. More than 10 provinces, such as Chongqing, Hebei, Liaoning, and Zhejiang, have already published EDL-usage requirements for hospitals. Most of them follow requirements set by the central government on EDL revenue share (by value), e.g., 100% in grassroots hospitals, no less than 20-30% in Class III hospitals, no less than 40% in Class II hospitals and no less than 50% in county hospitals that are participating in reform pilots. Compared with the cur-rent EDL usage, estimated at 10-15% and 27% NEDL and PEDL respectively by value share, the impact is expected to be signifi cant in terms of both expanding the EDL market and negatively impacting the non-EDL market, if the requirements are enforced.

Some stakeholders doubt the effectiveness of the mandate without suffi cient sup-porting mechanisms in hospitals, but we believe the stringent government require-ments will take effect to some extent because the heads of public hospitals in China, unlike hospital CEOs in most markets, act partially as government offi cials, and consider fulfi lling government requirements as one of their priorities for career development. At the same time, with fast improving IT infrastructure in hospitals, drug sales information will become more transparent, which will facilitate better monitoring and regulation of EDL implementation. In other markets, e.g., recently in Thailand, a strong linkage between cost-containment mechanisms, incentives of hospital directors and improved IT infrastructure has led to drastic results.

• Changing tendering model: There is an emerging tendering model that links EDL and RDL tenders. A company losing an EDL tender (or deciding not to participate in the EDL) will automatically lose the RDL tender altogether, or products bid as RDL must follow the price of winning EDL products at the same quality level. Hence, participat-ing in the EDL market becomes a must if there is broad tender linkage, and under-standing how to participate effectively in the EDL market becomes a critical issue.

Multiple provinces, including Beijing, Fujian, and Jiangsu, have already adopted this linkage model. If it turns out to be widely adopted, strategic questions for manufacturers will change from “whether to participate” to “how to participate,” i.e., what are the right pricing strategies, and how to adjust commercial models to capture the volume upside.

• Balancing between cost and quality factors: While industry players start to en-dorse heightened “quality” requirements in tenders, confi rmed by Beijing tender

T here are still many uncertainties affecting the EDL market development. Depend-ing on how several major swing factors evolve, McKinsey has projected three EDL market scenarios by 2020: The EDL market, including both national EDL and pro-

vincial EDL, will account for 30%, 34%, or 41% of the total pharma market by value in a “constraint scenario,” “base scenario” or “accelerated scenario,” compared with 27% currently. The major swing factors affecting growth of the EDL market include: how intensive the pricing pressure will be; whether funding and insurance to cover the new EDL will be suffi cient; whether volume-price linkage will be realized in tenders; how fast the progress of hospital payment scheme reform will be (so as to incentivize hospitals to use cheaper EDL products); how much fl exibility local government will have to expand provincial EDLs; and whether there will be another major EDL expansion by 2020.

FORECAST OF EDL MARKET


W hen looking closer at the EDL impact on each company, business leaders usually fo-cus on the products listed on the EDL, but overlook the impact of their non-EDL prod-ucts facing EDL competition, especially competition from other MNCs. They should

ask themselves the following strategic questions under the above two different scenarios.

For EDL products, pharma companies need to consider:

What happens if we participate in the EDL?

– What price is necessary to win the tender?

– What is the expected volume upside, including how many provinces do we expect to win; in which provinces can we still participate in the NRDL when losing EDL tenders?

What happens if we don’t participate in the EDL?

– What would be the pricing points to maintain to participate in the NRDL?

– How much revenue currently comes from grassroots institutes? Can we afford to lose the EDL market?

– How much of our market in large hospitals will switch to EDL after broader implementation is required?

– In which provinces will we lose the RDL market if we don’t participate in the EDL?

For non-EDL products with EDL competition, pharma companies need to consider:

What are the implications facing products with competition from EDL products?

– How much volume could potentially be lost competing with EDL products in different channels?

– What is the impact on price? How much price reduction is needed to remain competitive?

Is there an opportunity to participate in the EDL?

– In which circumstances should we pursue provincial EDLs (PEDLs)?

– What capabilities do we need for a PEDL play? (e.g., PEDL listing, tendering)?

– What price is necessary to win PEDL tenders?

– What is the expected volume upside?

Strategic Questions Related To The EDL


results in May 2013, Guangdong’s recent tender policy still focuses more on price and casts uncertainty about which way the industry will go in terms of the long term “quality-price” balance.17

In response to the new EDL expansion and related policies, while 15% of respondents still don’t have a clear strategy, 29% plan to decrease investments in products on the national EDL by adopting lower-cost commercial models and tools; 29% of respondents will maintain investments, but shift resources across channels or geographies and strengthen market-access capabilities; 17% of respondents will increase investments to drive penetration in lower-tier markets, hoping the volume uptake will mitigate price reductions; and 8% will decrease in-vestments and ramp down commercial efforts (Exhibit 13). The range of responses illustrates the degree of uncertainty that still surrounds the EDL.

In summary, we see an environment where pricing pressure and cost-containment measures are likely to take deep roots and increasingly impact the market, as central and provincial governments fi gure out what mechanisms work best. The upside for MNCs is a market that will behave in a more transparent way, and where volume growth could accelerate from current trends. However, it implies a need to fundamentally redesign the business model, for example with stronger market-access capabilities, and more dynamically change allocation of resources across the portfolio and across functions to support brands with the best growth prospects and shift resources away from the ones under severe or moderate pressure.

Exhibit 13MAJORITY OF EXECUTIVES EXPECT EDL TO HAVE NEGATIVE IMPACT TO THEIR BUSINESS, AND LESS THAN 20% PLAN TO INCREASE INVESTMENT FOR EDL PRODUCTS


No significant Impact

Negative Impact

Positive impact

7%

8%

29%

Others

2%15%

Percentage

Views on EDL impact Investment plan for EDL products

Percentage

How do you view the impact of the 2012 version EDL on your business?

How will you manage your products on NEDL?

31%

62%

Maintain

Increase

To be determinedDecrease: lower-cost commercial model

29%

17%

Decrease: ramp down

17 “New Guangdong Model Sets Dangerous Precedent For Next Round Of Drug Tenders,” PharmAsia News, May 29, 2013.


SECTION 3: THE INNOVATION IMPERATIVEChina’s R&D is at a crossroad. Starting with the 12th Five-Year Plan, China has upgraded biomedical as a strategic industry, a priority likely to carry on in the 13th Five-Year Plan and be-yond. Resources are fl owing, infrastructure is being built and world- class scientists are fl ocking back to the mainland, attracted by the research conditions and the potential for value creation.

Most industry players believe China can grow into a strong global contributor by 2025, and sustain an active local R&D ecosystem in which China-based centers of multinationals and Chinese companies make meaningful contributions to innovation in the form of new molecules brought to market. Before China becomes a source of global innovation though, MNCs are busy trying to shorten the launch timelines of their innovative products in China, sometimes with local partners to support local development path options. They do this in an environment fraught with challenges, where reten-tion of talents and integrity of data management are real con-cerns. This section of the report covers three key topics related to innovation: 1) the critical importance for MNCs to accelerate the introduction of their more innovative global products in Chi-na, as cost-containment measures create signifi cant exposure on mature brands; 2) the emerging trend of China-specifi c development deals with local part-ners to accelerate and strengthen pipeline development; and 3) the challenges of conducting R&D in China, and options for mitigating risks.

Critical importance of introducing global innovative products in China Across the industry, China portfolios are highly dependent on off-patent/mature brands that command a premium price versus local generics, but are coming under increasing pricing and cost-containment pressure. This “mature products dependency,” has historical and market access-specifi c reasons. Going back 10 or even a few years ago, MNCs did not systematically prioritize China as part of their global development plans. As a result, and given local data requirements and time-consuming steps for approval, many important drugs reached China only recently, with gaps of fi ve to seven years versus global launch dates. Beyond those delays in launch dates, MNCs have had to contend with adverse market-access conditions for innovation. Launching a new product requires a painstaking listing process at the hospital level, and access to reimbursement can take years, if ever secured (the NRDL was last updated in 2009 and the current consensus is that the next update will likely occur in 2014). As a result, new product launches cannot materially im-pact a large company’s performance, unlike in the U.S. or Japan for example. This is best illustrated by the “freshness index” of the top 10 MNCs in China, defi ned as contribution to sales from drugs launched within the past fi ve years. In this analysis, we calculated the contribution to total revenues of the products launched on the market since 2008. The aver-age comes out at 5%, with a range of 1-8% (Exhibit 14).

However, our survey reveals that MNC executives anticipate the situation to evolve quick-ly, as drugs launched in the last fi ve years will see their contributions rise signifi cantly by 2020, and pipelines will deliver positive contributions as well, supported by a healthy fl ow of more timely new product introductions. Portfolio shapes will therefore look quite different by 2020 for most companies. The freshness index of MNCs’ portfolios in China is expected to double from 5% today to 13% in 2018, according to our survey. Collec-tively, total contribution from patented drugs will grow from 23% today to 39% by 2018. Off-patent originator products are expected to shrink signifi cantly from 77% today to 61% of the portfolio due to generic competition and continued price cuts by NDRC (Exhibit 15).

Launching a new product requires a painstaking listing process at the hospital level, and access to reimbursement can take years, if ever secured.


Exhibit 14DRUGS LAUNCHED SINCE 2008 CONTRIBUTED ONLY 1%-8% OF TOP MNC PHARMACOS’ REVENUE IN 2012

SOURCE: RDPAC; McKinsey analysis

Drugs launched before 2008

Drugs launched since 2008

2012 top MNC pharmaco revenue (Rx only)

RMB billion; percentage

Top 5 New Products

Avastin (Roche)

Temodal (MSD)

Dynastat (Pfizer)

Sutent (Pfizer)

Xarelto (Bayer)

8% 8% 7% 6% 5% 4%

MNC 5

10

MNC 4

8

MNC 3

MNC 2

6

MNC 1

12

MNC 10

8

MNC 9

10

MNC 8

31%

MNC 7

7 63%

MNC 6

7

1% 1%

92% 92% 93% 94% 95% 96% 97% 99% 99% 100%

EDL drugs (2012 version)

Non-EDL off-patent originators

Other patented drugslaunched 5+ years ago

New drug launchedwithin past 5 years

100% 100%

49%

18%

5%

20182013

Sales contribution from different drug categories

Percentage

28%

13%

26%

39%

21%

Exhibit 15PIPELINE DRUGS EXPECTED TO CONTRIBUTE TO 13% OF MNC SALES BY 2018, COMPARED WITH 5% TODAY

SOURCE: RDPAC; McKinsey PharmAsia Summit Survey


It remains to be seen if the transition to innovative, patented products will be fast enough for all MNCs to generate sustainable growth given the downside risks on mature/off-patent drugs.

Emerging trend of local partnerships for China-specifi c developmentThe last 18 months have witnessed a signifi cant increase in the volume of development deals between MNCs and local companies. What is particularly interesting is the range of options being pursued by MNCs, from partnering with leading local companies (e.g., BMS with Sim-cere) to partnering with companies that were formed only recently (e.g., Roche with Ascletis) (Exhibits 16 and 17 ).

Not surprisingly then, our survey reveals that “forming partnerships with local R&D compa-nies” is the number one lever that MNCs plan to pull to improve their R&D operations in China. The main goals for local collaborations are to accelerate development of late-stage pipelines and identify potential opportunities to tap into “white spaces” in portfolios and platform capabilities (Exhibit 18). Clearly, we are in a “proof-of-concept” phase, as MNCs tend to partner assets that have been deprioritized globally or present a lower downside risk. We believe though that through the mid/long term, more strategic partnerships will emerge.

Exhibit 16MNCS ARE INCREASINGLY PARTNERING WITH LOCAL COMPANIES ON R&D DEVELOPMENT

SOURCE: RDPAC; press search, McKinsey analysis

Time DescriptionExamples

Dec. 2011

Jun. 2013

Dec. 2011

Dec. 2011

May 2013

Sept. 2012

non-exhaustive

Apr. 2013

May 2013

Co-develop and commercialize BMS’ Orencia for RA

Established JV with Beta Pharma to develop and commercialize Amgen’s Vectibix

Global licensing, co-development, and commercialization agreement for pre-clinical second-generation BRAF inhibitor called BeiGene-283

Ascletis licensed China rights for development, manufacturing and commercialization of a Phase II HIV candidate from Janssen

Established JV to develop, manufacture and potentially commercialize AZ’s experimental RA antibody MEDI5117

AZ in-licensed Phase I oncology molecule from Hutchison Medipharma for global development & commercialization

Roche out-licensed pre-clinical diabetes asset to Hua Medicine for global development

Co-develop BMS’ pre-clinical CVS compound BMS-795311 with Simcere retaining marketing rights in China


Exhibit 18MAJOR GOALS FOR LOCAL COLLABORATION ARE TO OBTAIN FASTER REGULATORY APPROVAL AND SPEED UP DEVELOPMENT BY TAPPING INTO EMERGING INNOVATION

SOURCE: McKinsey PharmaAsia Summit Survey

5%

18%

23%

27%

36%

9%

27%

23%

36%

41%

27%

32%

23%Lower development costs

18%

23%

Potential faster regulatory approval 32%

Speed in innovation

Innovation capabilities

Respondents’ rating of value add from local partnership(1- not significant at all, 7- most significant)

1 ~ 4 - not significant 5 - significant 6 - very significant 7 - most significant

Rationale for strategic collaboration

Danoprevir HCV, innovative molecule

discovered by InterMune with global rights acquired by Roche in 2010

Interferon (IFN)-based danoprevir triple therapy has demonstrated high cure rates in patients with genotype 1b, the predominant genotype of the virus in China

Danoprevir is also being investigated as part of an IFN-free combination, with an ongoing Phase II study

Owns global rights to danoprevir

Defines IFN-based danoprevir triple TPP

Grants exclusive license to Ascletis to manufacture, develop and register danoprevir in Greater China markets

Roche and Ascletis will collaborate for the clinical development and the commer-cialization of danoprevir

“Best of both worlds”intent

Fully localized development, including manufacturing

Accelerated speed to market relative to traditional development approach

Shared input on development strategy

Leverage Roche commercial platform

Sharing of some costs

Responsible for formulation development and clinical/commercial supply

Responsible for clinical development and regulatory affairs activities leading to approval by CFDA of defined TPP

Leverage other strategic partners to complement own capabilities for accelerated development

Exhibit 17CASE STUDY - ROCHE-ASCLETIS COLLABORATION ON DANOPREVIR IS A GOOD ILLUSTRATION OF A GROWING INDUSTRY TREND

SOURCE: Roche; interviews


CFDA released “Guidance on deepening the drug review and approval reform to further encourage new drug innovation” in February 2013. The main goals of the guidance are:

• Accelerated review for registration applications for innovative drugs

– Encourage innovation based on clinical value;

– Adjust strategy for evaluation of clinical trial applications for innovative drugs: the clinical trial application will focus on understanding of current medical treatment, new clinical value of the innovation, and protocol design to address these; and

– Optimize process for innovative drug evaluation, such as allowing submission of amendments during IND stage and enhanced communication from early phases.

• Develop supporting measures

– Revision of drug registration regulation;

– Improve technical guidance system;

– Optimal allocation of review and approval resources;

– Encourage drug registration outside of China; and

– Improve transparency of drug review and approval, as well as coordination within CFDA across departments.

Regulatory Reforms To Encourage Drug Development

18 “CFDA Aims For Bigger Staff, More Power For Provinces As Cabinet-Level Agency,” PharmAsia News, April 17, 2013.

Challenges of conducting R&D in China and risk mitigation factorsThough industry players expect an accelerating contribution from their innovative portfolios, today, R&D in China is still at its nascent stage, with both external policy/market challenges and internal challenges in the years to come.

“Lack of innovation-rewarding regulatory environment” and “lack of R&D talent” are rec-ognized as the biggest external challenges. New drug approval lead time is an important indicator of a rewarding regulatory environment. In the past fi ve years, the average gap between the fi rst major market and China approval was fi ve to seven years. For the 56 new molecules successfully launched in the U.S. during 2006-2012 from the top 12 MNC pharmaceutical companies, 17 experienced six-plus years of launch delays in China. As an example of the hurdles to overcome, China still requires local data for registration, and a typical new Clinical Trial Application (CTA) takes about a year to be approved by CFDA.

However, in fairness to the Chinese regulators, part of the delay can be traced back to questionable registration strategy choices applied by MNCs. Many companies recognized late the growth potential of China, and did not include China in global trials, leading to additional delays in submission of registration fi les in China. On average, market access is delayed for roughly fi ve to seven years for new launches in China compared to the U.S. CFDA has been improving its capacity and capabilities to address the issues of slow registration/approval (e.g., reorganization of the Center for Drug Evaluation, development of detailed approval pathways, etc.) with some help from industry.18


In the next fi ve to 10 years, R&D leaders we surveyed expect lag time for new product launches in China (compared to the U.S./EU) to improve marginally by one to two years. Some leaders were more optimistic, aiming to shave three to four years off the lag time (Exhibit 19). The consensus was that the mid-term target should be to launch prioritized products in China about two years after global approval.

Internally, “diffi culties to recruit and retain R&D talent” and “volatility and changes in com-mitment from global swinging levels of investment to China” are ranked as the most critical challenges. Heads of R&D in China report acute challenges in hiring management-level em-ployees with suffi cient scientifi c and leadership experience. The most diffi cult challenge of all is fi nding the right R&D general managers and functional leaders for China: individuals who can lead large teams effectively from discovery through late-stage clinical trials under a variety of organizational structures from solid line to a matrix organization. They must also drive great science, manage recruiting, and at the same time deal with the regulatory and cultural complexities of China. Recruitment and retention are growing ever more diffi cult and costly for MNC pharmaceutical companies, especially for experienced managers and senior scientists. Many top graduates prefer to join Chinese companies, where the pay is compa-rable and the career opportunities and cultural fi t are superior. Concerns about global’s commitment to China are twofold. On the salient level, an important indicator of global sup-port is R&D investment. As the R&D investment cycle is much longer than that for commercial operations, global’s consistent commitment is critical to ensure successful discovery and de-velopment. However, the real challenge to R&D heads is changing positioning of China R&D in the global picture. To many MNC pharmaceutical companies, despite heavy investment in China R&D, the positioning of “In China for China” vs. “In China for Global” is still not clear.

Despite the challenges, MNCs are attracted to conduct R&D in China as the “large market potential makes China too big to ignore.” The number of RDPAC member19 R&D centers in

Exhibit 19LAUNCH GAP IS EXPECTED TO MARGINALLY SHRINK BY 1-2 YEARS IN THE MID TERM


Industry players’ perspective on launch gap evolution

100%=25 respondents; percentage

20%

Significant improvement: lag shrinks by 3-4 years

80% Marginal improvement: lag shrinks by 1-2 years

19 In total, RDPAC has 38 MNC members, as of May 2013.


China has quadrupled over the last decade from seven to 30, providing high-quality employ-ment opportunities for some 3,000 scientists and clinicians, 80% of whom hold advanced degrees at the Master’s level or higher. In the next fi ve years, MNC pharmaceutical compa-nies will continue to invest in R&D in China, with annual spending CAGR of 15%, according to RDPAC. In 2012, RDPAC released a white paper titled “Building an innovation driven pharmaceutical industry in China.” The white paper focuses on RDPAC member companies’ commitment and impact on the development of China R&D, and suggestions on leapfrogging into the future.

According to our survey, MNCs see several important levers to improve R&D operations in China (Exhibit 20).

Beyond partnerships for local R&D, industry players identifi ed “improvement in people devel-opment programs, and focus on China-prevalent disease and ’In China for China‘approach” as the biggest levers to improve their R&D operations in China.

Improve people development programs. Innovation comes with people. Today Chinese students represent at least one-third of biology major graduate students in the U.S. Many of them are coming back to China to join the academic world or pharmaceutical indus-try, bringing back innovation brainpower and rendering another reason for MNCs to strengthen R&D in China. MNCs must keep investing to develop a compelling employee value proposition that provides strong reasons for top R&D talent to join and stay. This includes four elements: an engaging job, an exciting company reputation, an energiz-ing culture, and effective talent-development programs. Beyond this, MNCs need more programs to mold and develop new hires fresh from leading Chinese universities. Such

Regulatory

• Shorten clinical trial application review timeline;

• Open up policies on Phase I trials for new drugs manufactured outside of China;

• Harmonize processes and requirements to International Conference of Harmonization (ICH) standards;

• Establish Marketing Authorization Holder system for regulatory approval.

Reward for innovation

• Timely broad market access that enables patients to benefi t from new drug therapies;

• Reasonable pricing that rewards innovation and ensures drug quality and safety;

• Tax credits for R&D to encourage innovation.

Intellectual Property Rights (IPR)

• Reducing ambiguity of product defi nitions;

• Better integrating drug regulatory approval process with patent enforcement;

• Ensure pharmaceutical IPRs are safeguarded with adequate penalties for infringement.

Key Recommendations From 2012 RDPAC White Paper --“Building An Innovation Driven Pharmaceutical Industry In China”


programs should introduce new hires to the corporate culture, teach them the drug dis-covery process, provide English training they need, and develop their management and leadership skills.

Focus on China-prevalent disease and “In China for China” approach. Increasingly, R&D centers are focusing on diseases with a high prevalence in China, such as liver cancer and gastric cancer, though the decision to concentrate on these diseases should be carefully considered given the competitive intensity in such areas. Furthermore, companies should consider whether a R&D center will develop drugs for sale only in China (developing lo-cal solutions for local needs based on local standards), or develop products for the global market and be held to approval requirements from the U.S. and Europe as well as those in Asia. Many diseases with a high prevalence rate in China also have high prevalence rates in Japan and other Asian countries. Such “local” insight gained from research in China can therefore be applied to other Asian countries as well. “In China for China” suggests a certain degree of focus and priority, yet should not become a constraint on the potential impact of R&D efforts in China.

In summary, we see a China pharma market that increasingly is transitioning to innovation in response to government incentives and pricing pressure on off-patent medications. In the short term, MNCs are likely to accelerate China launches for global pipeline products and increase partnering with local companies for China-specifi c development. Over the long term, MNCs must continue to invest in people development programs to recruit and retain top R&D talent while focusing on scientifi c areas of differentiation, such as diseases with a high prevalence in China and/or greater Asia.

Exhibit 20FORMING PARTNERSHIPS WITH LOCAL R&D COMPANIES IS BIGGEST LEVER TO IMPROVE R&D OPERATIONS IN CHINA


Cultivate high caliber CROs 63%

Manage external innovation, e.g. collaboration with academic

75%

Better talent management to recruit and retain top R&D talent

75%

Target China-prevalent diseases and government priority

75%

Form partnerships with local R&D companies 88%

Percentage

Percentage of respondents who agree or strongly agree on big levers to improve R&D operations in China


SECTION 4: IMPLICATIONS AND PATH FORWARD FOR SUSTAINABLE GROWTH In the “Healthcare in China – Entering Uncharted Waters” report, published in September 2012, McKinsey & Company identifi ed eight principles for sustainable growth in China (Exhibit 21). Our conclusion after this tumultuous year is that the principles still hold true. Without revisiting all of them in detail, we highlight the following principles for sustainable growth: 1) Have a through-cycle mentality; 2) Tailor business models to better address market needs; 3) Step up engagement with central and local governments to shape the environment; 4) Double down on the role of innovation; and 5) Seek out bigger, bolder partnerships.

Have a through-cycle mentalityIn recent years, leading MNC pharmacos have signifi cantly increased their commitment to the China market. Many have made this clear through their investor communication, holding sessions focused on China operations and their strategy and growth prospects.

Big Pharma’s commitment to the China market is based on continuous outstanding performance amidst relative diffi cult conditions in other key markets, which has turned China into an important sales contributor. China already represents more than 5% of AstraZeneca’s global sales, and the percentage is as high as 8% for Novo Nordisk. Several big pharma have moved global func-tions and senior leadership to China to further drive performance. Bayer, for example, relocated the headquarters of its global primary care business to Beijing and AstraZeneca established a global clinical operations hub in China. AstraZeneca has the head of its International Operat-ing Unit (commercial) and the head of Asia and Emerging Markets iMed (research and early development) both based in Shanghai, and Sanofi decided to base its head of Asia in China.

Exhibit 21EIGHT PRINCIPLES FOR SUCCESSFUL GROWTH

SOURCE: McKinsey’s “Healthcare in China - Entering Uncharted Waters” report

Adopt a “second home market” mindset

Step up engagement with central and local governments to shape the environment

Tailor business models to better address diverse market needs

Drive operational improvements to sustain the economic model

Double down on the role of innovation

Seek out bigger, bolder partnerships

Invest in attracting and developing top talent, and building capabilities that are relevant to China

Have a “through-cycle” mentality


The most recent developments in the China market–including the unfolding compliance inves-tigations, and new behaviors by hospitals, such as restricting access to sales representatives–will provide a real “acid test” to those commitments. The market could experience a signifi -cant slow-down in the second half in 2013, and several companies are at risk of missing their budget targets. Beyond this, up and coming senior managers, traditionally competing for roles in China, could now see a rotation there in a very different light. We expect that some companies will reconsider development plans for China, both from an R&D and a commercial standpoint. Ultimately, the market’s potential will likely remain strong enough to continue to attract greater investments. We do believe though that the depth of commitment to China will be increasingly infl uenced by factors external to China and specifi c to companies, in-cluding fl ow of new products to bring to market (impacting range of opportunities outside of China), degree of global exposure to patent cliffs (driving short-term ability to invest), fi t of China disease profi le with overall portfolio and R&D focus, and ultimately, risk appetite of the top management team. In the short term, ensuring that top company talents continue to be assigned to China should remain a priority.

Tailor business models to better address market needsAs the market continues to quickly expand in several directions – broader portfolio, new channels, new cities – MNC pharmacos increasingly have to fi gure out where they should put their incremental investment dollars and how they should compete in those different seg-ments. For example, many are taking a serious look at the lower-tier market, which consists of customers beyond big cities and big hospitals. The lower-tier market is gaining attention because growth from the core market has been slowing down in Tier 1 cities. In contrast, the lower-tier market will be a key growth driver for the China pharma market, and is expected to grow faster than the overall market in the next few years.

For most MNCs in China, our survey indicated that the number one goal today is still to maxi-mize the topline. That picture is fast evolving though as companies are putting more weight on reaching healthy operating income ratios (Exhibit 22). As part of the effort to expand the topline, MNCs are expecting to increase the number of hospitals covered by their dedicated sales representative by 38% (Exhibit 23).

As alluring as the lower-tier market may look, it is not an easy one to crack. MNCs have tried many different commercial models to tackle the challenge. Sanofi , for instance, estab-lished a full-fl edged department to explore opportunities in the lower-tier market. It prioritizes therapeutic areas already present in county hospitals, such as cardiovascular with Plavix, and currently has over 200 staff members. MSD established a joint venture with local player Simcere to expand its portfolio and leverage Simcere’s capabilities in lower-tier markets. Novo Nordisk uses a light-touch model for the lower-tier market and launched a mentorship program to cultivate key physicians.

The most commonly piloted models are traditional sales forces, partnerships with distributors and remote physician education. Among the different models that have been tried, the most effective ones are traditional sales forces and dedicated organizations. But in the next three years MNCs are more likely to use partnerships with distributors and remote physician edu-cation, as pressure on margins intensifi es (Exhibit 24).

The lower-tier market question is just one illustration of strategic questions that MNCs need to answer when formulating their strategies for the mid/long term. Overall they need to de-velop a sharper perspective on “where and how to play,” based on portfolio, expectations

Many diseases with a high prevalence rate in China also have high prevalence rates in Japan and other Asian countries.


5%

2%

59%

4444%% 2277%% 2244%%

3344%%Maximize topline

Maximize operating margin (percentage)

Maximize topline


12%

24% 2222%% 2222%% 3322%%

1155%% 2222%% 5511%%

RRespondents’ rating of significance of different financial management goals FFiinnaanncciiaall mmaannaaggeemmeenntt ggooaallss DDiissttrriibbuuttiioonn ooff ssccoorreess

TTooddaayy

33-years from now

not significant significant very significant most significant

5%

Exhibit 22MNCS EXPECT A REBALANCING BETWEEN MAXIMIZING TOPLINE AND ACHIEVING HEALTHY OPERATING MARGINS


~4,600

In 5 yearsToday

~3,300

Today

69%

In 5 years

62%

1 Defined as hospitals in tier 1 and 2 cities

Estimated number of core hospitals1 covered and portion of sales force that covers core hospitals

Average number of core hospitals coveredNumber of hospitals

Portion of sales force that covers core marketPercentage

+38%-10%

Exhibit 23NUMBER OF CORE HOSPITALS COVERED WILL INCREASE BY 38%, WHILE PROPORTION OF SALES FORCES COVERING CORE MARKETS WILL DROP SLIGHTLY



for returns and existing capabilities. MNCs should develop a product-level granularity and forward-looking view on potential by channel. They should decide on the appropriate bound-aries of the potential they want to cover, and adapt the reach model based on projected economics (Exhibit 25).

Step up engagement with central and local governments to shape the environmentBeing able to shape the market and differentiate from competitors is key to achieving long-term leadership. Companies are pursuing a range of initiatives in that direction, displaying increasing creativity and willingness to put real investments behind market-shaping efforts.

Structurally, to stay closer to customers, some MNCs have established regional organizations. Bayer, for example, established regional offi ces in Beijing, Shanghai, and Chengdu, each with P&L ownership. MSD has organized its business in China into 10 regions, based on a city cluster view of the market, to address the uneven pace of development and policy imple-mentation at the local level.More recently, Roche established a West Region structure, with a goal to provide more focus on broader China, and Eli Lilly & Co. moved to a BU structure to better integrate market development efforts.20

Among key functions, Medical Affairs has seen a dramatic increase in role and size. Most leading MNCs now have teams of Medical Science Liaisons (MSLs) on-board, helping to drive medical guidelines and shape prescribers’ understanding of treatment benefi ts. We see

20 For further insights into this topic refer to “Regionalization – lessons from those who have tested the crab,” by McKinsey & Company, September 2012.

Exhibit 24MOVING FORWARD, MNCS ARE MORE LIKELY TO USE PARTNERSHIPS WITH DISTRIBUTORS AND REMOTE PHYSICIAN EDUCATION TO COVER THE BROAD MARKET


Traditional sales force

Dedicated organization structure and resources for lower tier market

PPartnerships with distributors

Low-cost reps (service reps)

RRemote physician education

Partnerships with local companies

Partnerships with contract sales organizations (CSO)

E-detailing

Call center/inside sales

16

17

24

14

23

36

19

27

27

17

20

20

22

22

23

24

28

29

Commercial model to cover broad market

# of companies that adopt this model today

# of companies that will use this model in 3 years


this as a positive development for the market, but one not absent of real challenges, including the ability to recruit suffi ciently qualifi ed medical affairs specialists, and the need to impose a shift in mindset in organizations to support the increasing role of Medical (e.g., allocation of budget, clarity on the role of Medical).

MNCs have also been increasingly active in shaping the market and addressing the market-access hurdles for expensive treatments. For example, to make its breast cancer therapy Her-ceptin (trastuzumab) affordable to a wider population, Roche has created a funding scheme together with Jiangsu province.21 The government will reimburse 70-75% of the fi rst six doses of Herceptin, and the Herceptin PAP from the Cancer Foundation of China (a partner of Roche) will donate up to eight doses for free for patients who purchased the fi rst six doses. Roche has a dedicated team working on the scheme, which covers a population of over 40 million people.22

In 2012, Baxter Corp. partnered with the Chinese National Institute of Hospital Administration under an endorsement from the Ministry of Health to address the awareness, access, and af-fordability challenge of peritoneal dialysis in the rural end-stage renal disease (ESRD) patient population. Baxter helped to develop treatment guidelines in rural areas by sharing interna-tional best practices. The company also provided patients with fi nancial support and invested in logistics systems to expand distribution scope (Exhibit 26).

21 ”Roche Looks To Improve Market Access In China Through Patient Assistance Programs, Reinsurance,” PharmAsia News, Sept. 12, 2012.22 ”How Pharmas Can Help Private Health Insurers Achieve A Larger Role In China,” PharmAsia News, May 7, 2013.

Exhibit 25 FOR EACH BRAND OF A GIVEN COMPANY, GEOGRAPHY/CHANNEL FOCUS NEED TO BE CLEARLY DEFINED

SOURCE: McKinsey analysis

Geography and channelsKey external and internal considerations (examples)

Channel Prefecture city County city/county

Geography

51- 286Top 50 Mid/small county

city/county

Larger county-level

city

CHC

Retail

ClassIII/IIA

ClassIIB/I

Big city/big hospital

“Lower-tier market”

Distribution of demand for drugs varies significantly from therapeutic area to therapeutic area

■

Stronger growth momentum in lower tier geographies (e.g., Tier 3 and 4 cities, county hospitals) than in Tier 1 cities

■

While relatively small today, CHCs and retail channels have potential to benefit from patient flow shifts driven by new policies

■

There are natural limits to the potential of sales force expansion – based on productivity requirements, operational complexity, etc…

■

Geography/channel focus are different by brands


At a more tactical level, Novo Nordisk has built a specialized team dedicated to running diabetes education programs. The programs are customized to the requirements of patients, physicians, and hospitals. With continuous education efforts, Novo Nordisk has earned high brand recognition. Moving forward, MNCs will need to continue to take active roles in shaping the development of the market, in particular working closely with central and pro-vincial-level governments to shape policies and unlock access to their drugs. Beyond ideas and resources, this will require a signifi cant step-up in capabilities, a much more integrated and dynamic approach to allocating resources, and the ability to foster more collaboration between the various key external stakeholders.

Double down on innovationTo further drive growth in the future, MNCs need to accelerate portfolio shift toward innova-tion. The demand for China innovation has been increasing as there are still many China-specifi c unmet needs. More importantly, the ecosystem for innovation in China has improved greatly due to a more favorable regulatory environment, expanded talent supply and capa-bility, and improved infrastructure.

Leading pharmacos have invested signifi cant R&D resources in China to establish R&D cen-ters and support regional and global trials. However, historically China has not been the R&D focus for MNCs. As a result, they have experienced long gaps between global and China launches. From 2006 to 2012, MSD launched eight new molecules in China and all had a launch gap of over two years. In the same period, Pfi zer launched 12 new molecules in China, and only two molecules had gaps of less than two years.

Baxter launched the “Flying Angel” program with MOH in 2012 to address these challengesChallenges of promoting peritoneal dialysis in rural ESRD patient population

Pilot launched in January 2013 in six provinces

Awareness: Limited PD endorsement policy, lack of patient education programs

Access: Shortage of PD-trained nephrologists, inadequate PD centers, lack of operation guide-line, insufficient coverage of distribution network

Affordability: Limited government funding, low affordability of co-payment

Train nephrologists and nurses in Class I/II and county hospitals

Invest in logistics system to expand distribution scope

Support treatment guidelines design by sharing global best practices

Draft treatment guidelines in rural areas

Conduct hospitals certification of PD treatment

Subsidize RCMI patients through lowering co-payment ratio

Exhibit 26CASE STUDY ON MARKET SHAPING INITIATIVE – BAXTER FLYING ANGEL EXAMPLE

SOURCE: MoH, Baxter, press search; McKinsey analysis


The situation is gradually changing as MNCs are including China in more and more global trials (Exhibit 27). However, the impact on the market will take time, as MNCs continue to “pay” for not including China in global clinical trials earlier.

In fact, given the timelines for registration in China and the slow uptake of products once on the market, prioritizing China over other programs or markets requires adopting a strategic, long-term view that runs contrary to traditional decision models. It also requires building clearer alignment between headquarters and Chinese operations on the trade-offs of doing development in China, and building trust at all levels, re-enforced by explicit mechanisms (e.g., scorecards, key performance indicators). It remains to be seen how the recent R&D-related negative news coming out of China for several MNCs will impact the broader trust equation between HQ and local affi liates.

Exhibit 27NUMBER OF PHASE III TRIALS INVOLVING CHINA


1 1 1

1 1 1 1

1 1

Total Ph III global trials2

China in Global trials

China in regional trials

China local trials

3

7

321

3 35

01 1

2

21 01 1

15

Biologics

Small Molecule

26 24 15 10 22 16 37

1 Each count represents one molecule*indication combination; if a molecule has multiple trials for the same indication,it is viewed as one count; includes all Phase III trials registered after Jan. 1, 2011.2 Involves patients from U.S. and other countries, excluding withdrawn, suspended and terminated trials.

MNC 1 MNC 2 MNC 3 MNC 4 MNC 5 MNC 6 MNC 7

Phase III trials in which China participates - 2011-131

non-exhaustive


Seek out bolder and bigger partnershipsTo address challenges of both portfolio and coverage, MNCs have established partner-ships across the value chain from research to development, manufacturing, distribution, and sales (Exhibit 28). The main goals of the partnerships and M&A deals are to enrich portfolios, expand commercial coverage in lower-tier markets, and strengthen government relationships (Exhibit 29).

Upstream, Bayer, for instance, established the Tsinghua-Bayer Innovative Drug Collaborative Research Center to expand its focus in biomedical research over three years.23 MSD invested in a fund managed by Cenova Ventures to incubate innovation. MedImmune, the global biologics arm of AstraZeneca, and Wuxi AppTec formed a joint venture to develop and com-mercialize a novel biologic drug. Lilly provides a particularly compelling example, with the Lilly Asia Ventures model, which has invested in the last few years in several promising local companies, including Beta Pharma Inc. and Innovent Biologics Inc.24

Exhibit 28MNCS ARE INCREASINGLY MAKING USE OF JVS AND PARTNERSHIPS, ACROSS THE VALUE CHAIN

SOURCE: Literature search; McKinsey analysis

Research Development Manufacturing Distribution, sales and marketing

Product development partnerships

23 ”BMS Dives Deeper Into China With First Discovery Partnership,” PharmAsia News, May 17, 2012. 24 ”Lilly Asia Ventures And Fidelity Boost Innovent Biologics Investment To Deepen Exposure To China’s Biologics Market,” PharmAsia News, Nov. 23, 2012.


Downstream, Amgen established a JV with Beta Pharma to commercialize a colorectal can-cer targeted therapy Vectibix (panitumumab). BMS and Simcere joined efforts to develop Orencia (abatacept) in China. MSD inked a JV deal with Simcere to expand portfolio and commercialization in lower-tier markets. Pfi zer established a partnership with local distributor Jointown Pharmaceutical Group Co., Ltd. in 2011.25 The strategic cooperation agreement grants Jointown distribution rights to Pfi zer products and controlling rights on distribution channels outside Pfi zer’s existing target markets including lower-tier cities and rural areas. Pfi zer also established a JV with Hisun in 2012 to manufacture and market branded gener-ics in China. The JV is “up and running” with 1,500 employees and revenues in the $700 million range.26

Clearly, the next few years will see a continuation of this partnership trend, and most likely an acceleration. MNCs realize that “they cannot do it all alone” and that access to specifi c ca-pabilities, or sharing of risks, is necessary to capture their full China potential. Entering China for companies “late to the party” will contribute to additional deal fl ow, with the Amgen-Beta Pharma JV a prime example. New local companies will emerge and position themselves as partners of choice for MNCs, while established local companies will continue to mature and become increasingly attractive as potential partners. For MNCs, success in developing part-nership strategies will rest on the caliber of individuals driving the partnership agenda, their ability to develop a compelling vision for the role of partnerships in the broader China strat-egy, and to align key headquarters stakeholders on the R&D and commercial side behind the vision, for what remains inherently a “high-risk, high-reward” environment.

Goals of M&A/partnerships % of votes

To expand commercial coverage in lower-tier markets

To enrich portfolio

To strengthen government relationships, e.g., for benefit on potential faster approval process and market access

To get access to local manufacturing capacity

To strengthen R&D capability 10%

20%

61%

69%

71%

What do you see as major goals of M&A/partnerships in China today?

% of votes

Exhibit 29MAJOR GOALS FOR M&A AND PARTNERSHIPS ARE TO ENRICH PORTFOLIO, PENETRATE LOWER-TIER MARKETS, AND STRENGTHEN GOVERNMENT RELATIONSHIPS


25 ”Pfi zer Teams With Distributor Jointown To Delve Deeper Into China’s Rural Markets,” PharmAsia News, Sept. 9, 2011.26 ”Pfi zer Looks To Ramp Up Branded Generics Via MOU With China’s Hisun,” PharmAsia News, June 2, 2011.


CONCLUSIONIn conclusion, China represents a unique opportunity for the pharmaceutical industry. The demographics are undeniable: huge unmet needs, aging society, adoption of Western life-styles, and a commitment by the government to increase access and support innovation. But real challenges exist, and they have become more acute over the past year. From rising pricing pressure and increasing-ly complicated cost-containment measures to a government drive to improve compliance, traditional business models in China are under pressure, and new strategies are needed to capture growth and profi tability.

Increasingly, government policies are converging around “cost effective” elements of health care reform. EDL expan-sion and pilot programs ranging from DRG to cost capitation point to a market straining to provide access to 1.3 billion citizens who are now covered by some variance of public insurance schemes. Looking ahead, hospital payment reform and application of international reference pricing could have a signifi cant impact on product portfolios, particularly off-patent medications, which currently represent 70-80% of multinational revenues in China. Perhaps it is not surprising then that our industry survey indicates that “reimbursement budget control” will pose the largest challenge to reimbursement policies in China over the next fi ve years.

These changes and others will require pharmaceutical companies to rethink traditional busi-ness models in China. Importantly, our survey points to a recognition that innovative drugs are required to differentiate portfolios in China and maintain premium pricing. Industry ex-ecutives will accelerate the introduction of global innovative products, working with their China R&D units and increasingly with local partners that can help speed China-specifi c de-velopment. MNCs will also focus on China-prevalent diseases, and will need to improve tal-ent recruitment and retention efforts. Many challenges will remain, from extended regulatory review times to complicated market-access requirements. Companies will need to increase engagement with central and local governments to help shape the market, collaborating on new schemes that increase affordability and outreach. And bolder and bigger partnerships will be needed to capture the vast opportunity and minimize risk. After all, no company can do everything in a market as large, complex and dynamic as China. Without a doubt the next 12 months will prove as eventful as the past 12 months. We look forward to those de-velopments and to sharing additional insights with industry leaders.

Our industry survey indicates that “reimbursement budget control” will pose the largest challenge to reimbursement policies in China over the next fi ve years.


APPENDIX I:

Glossary


BMI Basic Medical Insurance. A public insurance plan that aims to cover all Chinese citizens by providing basic medical service. The insurance system consists of three government insurance programs: Urban Employee Basic Medical Insur-ance (UE-BMI) launched in 1998 for employees in cities; Urban Residents Basic Medical Insurance (UR-BMI) for unemployed citizens in cities since 2007; and New Rural Cooperative Medical Scheme (NRCMS/NCMS) for 800 million citizens in rural areas since 2003.

CFDA China Food and Drug Administration. An agency under China’s State Council in charge of quality supervision, regulatory oversight and product approvals for pharmaceuticals, medical devices and food. Formerly known as SFDA, it was an agency under the Ministry of Health until it became independent in March 2013 (http://eng.sfda.gov.cn).

CHCs Community Health Centers. China primary care institutions that offer basic medical and public health services. They are regarded as the basic network for medical treatment and public health surveillance in China. As of 2011, there were 32,812 community health centers in China.

CMA Chinese Medical Association. A non-profi t registered academic and common-wealth corporate body voluntarily formed by Chinese medical science and tech-nology professionals. Established in 1915, CMA now has 84 specialty societies under its umbrella, covering all medical fi elds. The mission of CMA includes uniting and organizing medical professionals and implementing the principle of science, technology and health care of the State (http://www.cma.org.cn/ensite).

CPA Chinese Pharmaceutical Association. A national organization of pharmacists and pharmaceutical scientists with a mission to represent and serve pharmacy and pharmaceutical sciences development in China. Founded in 1907, CPA has nearly 3,000 senior individual members and 35 group members (http://www.cpa.org.cn).

CTA Clinical Trial Application. An application that sponsors must fi le with China FDA before conducting clinical trials in China. Clinical trials may not start in China until regulatory approval is received (http://eng.sfda.gov.cn/WS03/CL0769/61659.html).

EDL Essential Drug List/National Essential Drug List/Provincial Essential Drug List. A list developed by the Ministry of Health that includes drugs most commonly prescribed in Chinese hospitals. The NEDL was last updated in March 2013, expanding to 520 drugs, up from 307 drugs in the 2009 version. In addition to the national list, many provincial governments include additional drugs in their provincial EDLs. EDL drugs are subject to retail price ceilings set by NDRC, and are procured via centralized provincial tenders that further slash prices.

EDS Essential Drug System. One of fi ve key elements of health care reform in China, the EDS provides 100% reimbursement under government insurance for the most common treatments in China (which are listed on the EDL). The system re-quires hospitals to eliminate the traditional 15% drug markup at the pharmacy. As the government has pushed usage of essential drugs in community health centers, and more recently public hospitals, multinational companies have tried to keep their products away, given greater pricing pressure.

NEDLPEDL


IRP International Reference Pricing. A common strategy to control prices of pharma-ceuticals by benchmarking pricing to selected major markets. For China, pric-ing in other emerging markets like Brazil and India are key countries to watch.

MNCs Multinational Companies. Foreign companies in China. The defi nition also usu-ally includes their joint ventures in the country.

MoH Ministry of Health. The Ministry of Health was established in 1949. A ministry level department under China’s State Council, MoH designs health laws, regula-tions and policies, and manages public hospitals and the medical system in Chi-na. In March 2013, MoH merged with the National Family Planning Commis-sion to become the National Health and Family Planning Commission of China.

NDRC National Development and Reform Commission. An agency under China’s State Council in charge of economic and social development. For the pharma industry, NDRC sets retail price ceilings for drugs reimbursed under China’s government health insurance plans (http://en.ndrc.gov.cn)

NHFPC National Health and Family Planning Commission. A ministry-level agency under the State Council, formed by the merger of the former Ministry of Health and National Family Planning Commission. NHFPC is responsible for drafting health laws, regulations and policies, and manages the public hospital and medical system in China. It also operates the New Rural Cooperative Medical Scheme, the largest of three government insurance plans (http://www.npfpc.gov.cn).

NRDL National Reimbursement Drug List/Provincial Reimbursement Drug List. A list of reimbursable drugs drafted by the Ministry of Human Resources and Social Security. Government insurance reimburses for drugs on the list. NRDL drugs are subject to retail price ceilings and periodic price cuts from NDRC. The list is divided into two categories: Class A drugs (which include EDL drugs) are fully reimbursed; Class B drugs are partly reimbursed. The latest update from 2009 added 260 drugs to the list, bringing the total to 1,164 chemical drugs and 987 TCMs. The next NRDL revision is expected in 2014. Provincial govern-ments are allowed to make additions to the national list for provincial lists.

PAP Patient Assistance Program. PAPs are generally sponsored by pharmaceutical companies in collaboration with charity organizations to provide free or dis-counted medicines to people with low-to-moderate-incomes, and uninsured and under-insured people who meet eligibility guidelines. Eligibility and application requirements vary from program to program. In China, MNCs sponsor PAPs for several high-price targeted therapies that are not reimbursed under government insurance.

RDPAC R&D-based Pharmaceutical Association Committee. A non-profi t organization under the China Association of Enterprises with Foreign Investment. With 39 members companies, RDPAC represents the interests of big pharma in China. It is a member of the International Federation of Pharmaceutical Manufactur-ers & Associations (IFPMA) and a counterpart in China to the Pharmaceutical Research and Manufacturers of America (PhRMA) in the U.S.

PRDLRDL

Appendix I (continued)


State The chief administrative authority of the People’s Republic of China, often called “China’s cabinet.” It is chaired by the premier and includes the heads of each governmental department and agency. After a restructure in March 2013, there are now 25 minister-level departments under the State Council (http://english.gov.cn).

TCM Traditional Chinese Medicine. Herbal medicines developed in China with more than a 5,000 years history. Starting in the 1950s, China began to modernize TCMs to integrate many anatomical and pathological notions with modern scientifi c medicine. Nonetheless, some of its methods, including the model of the body, or concept of disease, are not supported by modern evidence-based medicine. Several big pharma have expressed interest in the potential for TCM. Novartis’ anti-malaria drug Coartem is commonly regarded as the fi rst modern medicine based on TCM research.

THCs Township Health Centers. Grassroots health centers in rural areas of China. THCs provide basic medical services to rural populations. As of 2011, there were 37,374 township health centers established in China.

Council

Appendix I (continued)


APPENDIX II:

Elsevier, BayHelix & McKinsey

PharmAsia Summit Survey Results


2

Interviewees’ positionPercentage

Sales/Marketing22

Generalmanagement30

MedicalOthers 4

BD 4

6

Finance 12

Strategy 8

R&D

12

Interviewees’ functionPercentage

Investment Bank

Pharma/ Bio-pharma96

Interviewees’ industryPercentage

Local 0

MNC100

MNC vs. localsPercentage

2Responsible for Asia/AP Region

6Exec Director/

Director (GM-2) 18

Country head/GMCountry level functional head

28 EVP/VP (GM-1)

46

Asia/AsiaPacific Region level manager

Commercial (e.g. KA,SFE, commercial team

VC2

2

Size of the China organization (all personnel)Percentage

Size (FTE) of the sales force Percentage

Mostly primary care, some specialty care38

Not applicable

6Roughly equal split between primary care and specialty care 20

Mostly specialty care, some primary care 36

Portfolio compositionPercentage

3,000 - 4,00012

4,000 - 5,00016

Over 5,000

12

Not applicable

10Less than 1,000 20

4

2,000 - 3,000

26

8

Over 10,000

4Less than 1,00020

1,000 - 3,000 8

3,000 - 5,000

34

5,000 - 7,00026

7,000 - 10,000

1,000 - 2,000

DISTRIBUTION OF SURVEY RESPONDENTS (Q1-Q4)

DISTRIBUTION OF COMPANIES THE SURVEY RESPONDENTS REPRESENTED (Q5-Q7)


Appendix III (continued)

Contribution to global sales from mainland China business todayPercentage

Contribution to global sales from mainland China business in 5 yearsPercentage

Not sure

More than 10%

7 -10%

5 - 7%

3 -5%

<3%

130

27

33

207

Not sure

More than 10%

7- 10%

5- 7%

3 -5%

<3%

20

33

13

13

13

7

CONTRIBUTION TO THE COMPANY FROM NON-EDL OFF-PATENT ORIGINATORS WILL SHOW THE LARGEST DECLINE IN 5 YEARS (Q8)

CONTRIBUTION TO GLOBAL SALES FROM CHINA WILL SIGNIFICANTLY INCREASE IN 5 YEARS (Q9-10)

Contribution to sales from respective categories today Contribution to sales from respective categories in 5 years

Patented drugs already on market today

100%Pipeline drugs not launched today

28%

23%

0%

100%

22%

33 99 %%

26%

13%

499%Non-EDL off-patent originators

EDL drugs (assuming 2012 version EDL)

Pipeline drugs not launched today

Patented drugs already on market today

Non-EDL off-patent originators

EDL drugs (assuming 2012 version EDL)

Average Average



China’s importance in the company’s current global strategic priorities todayPercentage

China’s importance in the company’s global strategy in 5 yearsPercentage

Not a Top 5 priority

4

Top 530

Top 3

61

Number 1 priority

4

Not a Top 5 priority

4

Top 548

Top 348

BIG PHARMA PLAYERS HAVE RECOGNIZED CHINA’S STRATEGIC IMPORTANCE AND WILL PUT MORE EMPHASIS ON CHINA’S STRATEGIC PRIORITY IN 5 YEARS (Q11-Q12)



2%

4%

2%

2%

2%

2%

2%

2%

22%

32%

14%

34%

48%

38%

22%

16%

30%

20%

30%

28%

30%

28%

22%

20%12%

14%

12%

12%

8%

8% 8%

10% 6%

10% 8% 20%

6%

12%

8% 16%

20%

6%

6%

46% 6.2Increase in patient flow due to aging and increase in disease prevalence

4.5Improvement in innovation infrastructure and R&D talent pool

Rise of innovative local companies that provide partnership opportunities

Favorable policy support to innovation, e.g. green channel for new drug approval

Improving health infrastructure and access in lower tier markets

4.5

4.8

5.3

5.3Improving public/private insurance coverage

5.7Growing disease awareness due to better access to information and improving diagnostics

Trends that boost growth Distribution of scores Average score

Statistics of scores that indicate the significance of each trend that boosts growth (1 - not significant at all, 7 - most significant)

1 ~ 4 - not significant 5 - significant 6 - very significant 7 - most significant Not available

AGING/INCREASE IN DISEASE PREVALENCE AND GROWING DISEASE AWARENESS WILL MOST SIGNIFICANTLY SUPPORT THEIR GROWTH IN THE NEXT 5 YEARS; WHILE INNOVATION (INFRASTRUCTURE, POLICIES AND PARTNERSHIP) IS DEEMED AS BIGGEST GAP TO DRIVE FUTURE GROWTH (Q13)



DELAYED/LACK OF REIMBURSEMENT FOR INNOVATIVE DRUGS AND FRAGMENTED TENDER AND INTENSIFYING PRICING PRESSURE WILL MOST SIGNIFICANTLY HINDER THEIR GROWTH IN THE NEXT 5 YEARS (Q14)

2% 2%

2%4%

2%

2% 2%

2%

2%

2%4%

18%

14%

18%

14%

14%

14%

24%

34%

26%

24%

44%

38%

24%

30%

4%

12%

12%

46%

4%

20%

6% 16% 6%

10% 24%

6% 46%

6%

10%

6%48%

10% 38%

8%Slow registration process for innovative products

4.8Lack of effective commercial approach to sufficiently serve demands in broad market (lower tier cities and lower class hospitals)

Growing competition from cheap alternative drugs hindering adoption of innovative/quality products

EDL expansion and erosion of non-EDL market in large hospitals

Public hospital reform (e.g., Zero markup, DRG, total budget control)

5.0

5.0

5.6

5.9

6.0

Trends that hinder growth Distribution of scores

Statistics of scores that indicate the significance of each trend that hinders growth (1- not significant at all, 7- most significant)

6.0

Fragmented tender and intensifying pricing pressure

Delayed and lack of reimbursement for innovative drugs

Average score

1 ~ 4 - not significant 5 - significant 6 - very significant 7 - most significant Not available



EXPANDING SALES FORCE TO INCREASE COVERAGE AND DEEPENING PENETRATION MOST SIGNIFICANTLY BOOSTED THEIR GROWTH IN THE PAST 5 YEARS (Q15)

4%

4%

2%

2%

4%

2%2%

4%

4%2%


5.8

3.9

4.3

4.3

5.0

6.1

5.0

Strategies that boost growth in past 5 years Distribution of scores Average score

Statistics of scores of success factors in the past five years

3.9

4.3

5.2

1 New segments include: 2nd-3rd tier city/ brand generics, new TA/OTC and developing CNS markets through promotional efforts/CME

14%

20%

18%

18%

8%

16%

36%

24%

20%

22%

12%

16%

22%

18%

20%

26%

28%

24%

26%

26%

20%

40%

36%

30%

14%

26%

16%

14%14%

10%

8%

30%

30%

12%

14%

16%

6% 8%

10%

Strengthen organization capabilities in marketing, medical, GA, SFE, etc.

10%

Introducing innovative products into China 30%

Expanding sales force to increase coverage and deepen penetration

8%

Securing broader footprint in China market through local acquisition/partnership/collaboration

6% 8%

Established partnerships with the government on disease awareness campaigns, patient access program, etc.

10% 10%


Organization restructuring 6% 8% 6%

Adopting new commercial models 6% 36%

Expand portfolio or pipeline for China through local acquisition/partnership/collaboration

46%

Entry into new market segments1

6%

(1- not significant at all, 7 - most significant)

6%

not available



IN THE NEXT FIVE YEARS, INTRODUCING MORE INNOVATIVE PRODUCTS IS CONSIDERED AS MOST EFFECTIVE GROWTH DRIVERS (Q16)

4%4%

2%

2%

2%

2%

2%

2%

4%

1 ~ 4 - not significant 5 - significant 6 - very significant 7 - most significant not available

8%

14%

12%

18%

12%

26%

26%

30%

18%

10%

16%

14%

16%

34%

14%

32%

20%

40%

26%

28%

16%

18%

28%8%

8%

8%

30%

28%

38%

42%

10%

28%

30%

8%

Adopting new commercial models

4%

16%

Making sufficient resource investments to strengthen organization capabilities in marketing, medical, GA, SFE, etc.

16%


Organization restructuring (e.g., regionalization)

Entry into new market segments1 6%

6% 20% 14%

Securing broader footprint in China market through local acquisition/partnership/collaboration

6% 14%

Expanding sales force to increase coverage and deepen penetration

6% 12%

6%

Established partnerships with the government on disease awareness campaigns, patient access programs, etc.

60%

8%

6%

20%

28%

Introducing innovative products into China

Expand portfolio or pipeline for China through local acquisition/partnership/collaboration

4%

6.5

3.8

4.7

4.1

5.1

5.0

5.4

5.5

5.7

5.3

Strategies that boost growth in next 5 years Distribution of scores Average score

Statistics of scores of success factors in the next five years(1- not significant at all, 7 - most significant)

4%

4%2%

1 New segments include: 2nd-3rd tier city/ brand generics, new TA/OTC and developing CNS markets through promotional efforts/CME



IN NEXT 5 YEARS, DIMINISHING INDIVIDUAL PRICING STATUS FOR ORIGINATOR OFF-PATENT PRODUCTS AND LARGE SCALE EDL IMPLEMENTATION ARE MOST LIKELY TO SEVERELY IMPACT MNCS (Q17)

Low impact Medium impact High impact

43%

57%

50%

57%24%

17%

19%

19%

33%

7% 36%

5%

52%

5%

24% 71%

2%

79% 2.8

2.0

2.2

2.3

2.5

2.7

Pricing situations Distribution of scores Average score

Statistics of scores that indicate the impacts of various pricing situations

(1-low impact, 3-high impact)

Large scale of EDL implementation

Diminishing individual pricing status for originator off-patent products

Continued rounds of NDRC price cuts

Downward pricing pressure from provincial tenders

Secondary negotiation by hospitals

Adopting International Price Reference in setting price for launch drugs



BIGGEST CHALLENGE FROM THE REIMBURSEMENT POLICIES IN THE NEXT 5 YEARS IS REIMBURSEMENT BUDGET CONTROL POLICIES (Q18)

Top challenge 2nd toughest challenge 3rd toughest challenge

Challenges # of votes (total votes in bold)

Statistics of votes on the 1st, 2nd and 3rd toughest challenge from the reimbursement policies in the next 5 years

Long updating cycle for National Reimbursement Drug List

Reimbursement budget control policies

Lack of reimbursement for innovative drugs

Limited scale and slow development of Private Health Insurance

Limited scale of implementation of catastrophic disease insurance

15

12

11

3

9

14

10

7

2 72

102 1

3413

3711

3814Toughest

Easiest



IN THE LOW COST ENVIRONMENT, ENGAGING IN LOBBYING AND STAKEHOLDER ENGAGEMENT EFFORTS AND SHIFTING PORTFOLIO FOCUS ON INNOVATIVE PRODUCTS ARE BELIEVED TO BE THE MOST EFFECTIVE LEVERS TO DRIVE SUCCESSFUL GROWTH (Q19)

2%2%

5%

5%

2%

5%

5%

2%


17%

19%

21%

31%

38%

31%

21%

17%

26%

29%

21%

26%

26%

14%

24%

24%

26%

29%

29%

26%

21%

12%

26%

19%

17%

12%

Push for local manufacturing to reduce cost base 7% 10%

Partner with private health insurance to enhance affordability of innovative drugs 7%

Pursue price volume agreements in provincial tenders 10%

Adopt lower cost/more effective commercial models to capture market potential(e.g., seek collaboration with local companies to go after “mass” market)

10%10% 10%

Invest in evidence generation (e.g., trials, pharmaco economics) to differentiate against low cost generics 7% 7%

More aggressively pursue improvements in sales force effectiveness

10% 12%

Shift portfolio focus on patented innovative products less affected by low cost environment

7% 21%

Engage in lobbying and stakeholder engagement efforts to limit cost containment practices (e.g., price cut, BMI budget control) 10%10% 17% 5.3

3.6

3.9

4.5

4.6

4.8

5.2

Trends that hinder growth

Statistics of scores that indicate the effectiveness of levers to drive success in the low cost environment

4.1

Distribution of scores Average score


7%



THE VIEWS ON THE IMPACT OF THE 2012 VERSION EDL ARE LARGELY NEGATIVE (Q20)

31

62

7

2012 EDL will not have a significant impact on my company’s business

2012 EDL will have mostly a negative impact on my company’s business. Volume upside will be more than offset by price pressure and process favoring local companies

2012 EDL will have mostly a positive impact on my company’s business with significant volume upside. Increasing attention for quality mitigates price pressure

Views on EDL impact % of votes Reasons (quotes)

Statistics of the views on the impact of the 2012 version EDL

National policy and largest provinces should favor retention and expansion for branded products

Competitor drug got EDL listing. Will improve market share but may have volume impact - especially in hospitals with no listing

Will have to compete directly on price with generics. The impact will be greater if EDL bidding is linked to general provincial bidding.

With price cuts, uncertainty of provincial tendering are much more likely to be downside than upside since most of the drugs listed in 2012 EDL have been generics.

Depending on the extent of mandatory price adjustment by NDRC, the increased volume is unlikely to compensate for price impact of say 20%.

Already widely reimbursed in provinces and on PEDLDepends on the specific policy and implementation



VARIOUS DIFFERENT STRATEGIES ARE ADOPTED TO MANAGE PRODUCTS ON NEDL (Q21)

Decrease investment: Adopt lower cost commercial models and tools to capture market opportunity

Maintain investment: No change in overall investment, may shift resources across channels or geographies, and strengthen market access capabilities

Increase investment: Drive penetration in lower tier markets

Ways to manage products % of votes Reasons (quotes)

How will you manage your products on the NEDL?

2

15

8

29

29

17

Decrease investment: Ramp down investment

Strategy to be determined

Already active in most areas, don't expect huge price cuts

Depending on bidding outcome and the price level after bidding

Strategy will be highly dependent on policies and opportunities by provinceDepends on the specific policy and implementation

New commercial models need to be established regardless the financial impact is positive or negative

Co-share the commercial risks of distributors while partnering with them to penetrate lower tier markets

Others



NUMBER OF HOSPITALS COVERED WILL INCREASE BY 38% ON AVERAGE IN THE NEXT 5 YEARS, WHILE THE SALES FORCE COVERAGE ON CORE MARKET1 WILL SLIGHTLY MOVE AWAY TO BROAD MARKET (Q22)

Estimated number of hospitals covered and portion of sales force that covers core market

4,572+38%

In 5 yearsToday

3,317

Number of hospitals covered (average)

62%69%-10%

In 5 yearsToday

Portion of sales force that covers core market (average)

Penetrate low-tier cities and cover lower class hospitals

MOVING FORWARD, MNCS ARE MORE LIKELY TO USE PARTNERSHIPS WITH DISTRIBUTORS AND REMOTE PHYSICIAN EDUCATION TO COVER THE BROAD MARKET (Q23)

Traditional sales force

Dedicated organization structure and resources for lower tier market

PPartnerships with distributors

Low-cost reps (service reps)

RRemote physician education

Partnerships with local companies

Partnerships with contract sales organizations (CSO)

E-detailing

Call center/inside sales

16

17

24

14

23

36

19

27

27

17

20

20

22

22

23

24

28

29

Commercial model to cover broad market

# of companies that adopt this model today

# of companies that will use this model in 3 years



WHAT DO YOU BELIEVE THE LEVEL OF CHINA INNOVATION WILL BE LIKE IN 5 YEARS’ TIME? (Q24)

Statistics of votes on the level of China innovation % of votes

Plateaued2

Strong contributor1

World-leading innovation hub3

9%

52% 39%

26% 17% 57%

65% 30%

4%

35% 52% 13%

4% 9%

87%

61% 39%

Challenges In 5 years In 10 years

1 active and improved local R&D, with some but limited participation in other global markets, largely a global market followee2 locked out of global innovation network, no active participation in global R&D, unattractive destination for top R&D talent/investment3 skillful economic, infrastructural and regulatory choices, a vital member of the network similar to the US today

Most likely Second likely Least likely



Significant improvement: lag shrinks by 3-4 years 20

Marginal improvement: lag shrinks by 1-2 years

80

No improvement

0

Statistics of votes on possible product launches growth in the next 5-10 years

% of votes

Statistics of votes on possible innovations in the next 10 years

% of votes

Novel compounds

20

Same drugs, but innovative formulation or administration pathway

23

Me-too drugs and branded Gx

25Biosimilars and biobetters

32

Annual spending growth rate

19%

Statistics of estimates of annual spending growth rate in China’s R&D organizations for next 5 years

Ave.

WHAT IS YOUR EXPECTED ANNUAL SPENDING GROWTH RATE IN CHINA’S R&D ORGANIZATION FOR THE NEXT 5 YEARS? (Q25)

WHAT TYPE OF INNOVATION DO YOU THINK WILL COME FROM CHINA IN THE NEXT 10 YEARS? (Q26)

CURRENTLY, THE NEW PRODUCT LAUNCHES IN CHINA STILL LAG SIGNIFICANTLY BEHIND THAT OF THE US/EU, HOW DO YOU SEE THIS LAUNCH GAP EVOLVE IN THE NEXT 5-10 YEARS? (Q27)



WHAT ARE THE MAIN POLICY / MARKET CHALLENGES HOLDING BACK FASTER DEVELOPMENT OF INNOVATION IN CHINA IN THE NEXT 5 YEARS? (Q28)

1 ~ 2 - not significant 3 ~ 4 - indifferent 5 ~ 7 - very significant

Statistics of scores that benchmark the main policy/market challenges

(1- not significant at all, 7- most significant)

6.4

3.8

4.9


22%

22%13% 43%Lack of infrastructure in terms of local partners and CROs 13% 9%

Lack of R&D talents

4%

39% 22% 13%

Lack of innovation-rewarding regulatory environment1 22% 17% 61%

1 e.g., long approval time, lack of reimbursement for innovative drugs



DIFFICULT TO RECRUIT AND RETAIN R&D TALENTS IS THE MAIN INTERNAL CHALLENGE FOR COMPANIES TO BUILD R&D CAPABILITIES IN CHINA (Q29)

4%4%

4%4%

4%

4%

4%

4%

4%


Statistics of scores that benchmark the main internal challenges ((1- not significant at all, 7- most significant)

5.1

4.7

4.8


22%

26%

17%

43%

17%

13%

35%

13%

13%

Inefficiencies in internal process 35% 17%

China R&D’s position unclear (’In China for China’ vs. ’In China for Global’) 9% 9% 30% 30%

Lack of alignment between global and China on the long term potential of China 26% 26%

Volatility and changes in commitment from global. Swinging levels of investment to China from global 22% 26% 17%

Concern over trial quality in China 26% 22% 9%

Difficult to recruit and retain R&D talents 9% 26% 17%

4.6

4.4

4.6

4%



LARGE MARKET POTENTIAL MAKING CHINA “TOO BIG TO IGNORE” IS DEEMED AS CHINA’S ADVANTAGE IN ATTRACTING COMPANIES TO CONDUCT R&D HERE (Q30)

4%


Statistics of scores that benchmark the main advantage/strengths

6.3

4.0

4.617%

22% 30%

35%

43%

Cost advantage 9% 26% 13%

Support by government policies 9% 9% 22% 13%

Talent supply for discovery and development 17% 17% 13%

Large market potential making China "too big to ignore" 22% 26% 52%

4.0





FORMING PARTNERSHIPS WITH LOCAL R&D COMPANIES IS PERCEIVED TO BE THE BIGGEST LEVER TO IMPROVE R&D OPERATIONS IN CHINA (Q31)

Cultivate high caliber CROs 63%

Manage external innovation, e.g. collaboration with academic 75%

Better talent management to recruit and retain top R&D talents 75%

Target China-prevalent diseasesand government priority

75%

Form partnerships with local R&D companies 88%

Percentage

Percentage of respondents who agree or strongly agree as big lever to improve R&D operations in China



IN R&D PERSPECTIVE, POTENTIAL FASTER REGULATORY APPROVAL IS VALUED MOST FROM A LOCAL PARTNERSHIP (Q32)

5%

5%

5% 5%

5% 5%

5%

Statistics of scores that benchmark the most valuable options


5.8

5.1

5.4


Lower development costs 27% 36% 23%

Innovation capabilities 9% 14% 23% 32% 18%

Speed in innovation 14% 27% 27% 23%

Potential faster regulatory approval 14% 9% 41% 32%

4.8




5%

2%

59%

4444%% 2277%% 2244%%

3344%%Maximize topline


Maximize topline


12%

24% 2222%% 2222%% 3322%%

1155%% 2222%% 5511%%

RRespondents’ rating of significance of different financial management goals

FFiinnaanncciiaall mmaannaaggeemmeenntt ggooaallss

DDiissttrriibbuuttiioonn ooff ssccoorreess

TTooddaayy

33-years from now

not significant significant very significant most significant

5%

MNCS EXPECT A REBALANCING BETWEEN MAXIMIZING TOPLINE AND ACHIEVING HEALTHY OPERATING MARGINS (Q33)



PORTFOLIO NOT ALIGNED WITH CHINA MARKET NEEDS AND CAPABILITY OF THE LOCAL TEAM ARE BELIEVED TO BE THE BIGGEST INTERNAL BARRIERS TO SUCCEED IN CHINA (Q34)

Strategic Barriers

Portfolio not aligned with China market needs

% of votes

Risk averse mentality

Limited understanding of the China market dynamics and potential from global

Unclear roles, process and decision rights

Slow decision making within China

Lack of focus on target customers/markets

27%

29%

31%

33%

35%

41%

43%

2%

4%

18%

18%

24%

Most common internal barriers

Capability of local team

Slow decision making process at Corporate HQ/regional level

Lack of high quality market insights

Lack of alignment of priority execution tasks

Insufficient resources

Lack of alignment on overall strategy

What are the biggest internal barriers to succeed in China?

ONLY HALF OF THE ORGANIZATIONS SURVEYED ACTIVELY MANAGE THE SALES FORCE AND CONTINUOUSLY IMPROVE THE PERFORMANCE (Q35)

Others

2

Sales productivity is closely managed and we expect significant improvement every year

2

41 54

Survey of sale force management% of votes

China is unique, we are not yetlooking for productivity

Sales productivity is monitored,but is not actively managed


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