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Driving Growth in the Turbulent Chinese Pharmaceuticals Market Franck Le Deu Rajesh Parekh Jin Wang October 2008 Part 2: Developing deep market insights, ensuring comprehensive market access, managing an expanding sales force, establishing reliable distribution channels

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Page 1: China McK 0209

Driving Growth in the Turbulent Chinese Pharmaceuticals Market

Franck Le DeuRajesh ParekhJin Wang

October 2008

Part 2: Developing deep market insights, ensuring comprehensive market access,

managing an expanding sales force, establishing reliable distribution channels

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Most multinational pharmaceutical companies (MNPs) continue to view China

as a significant opportunity. After a somewhat slow year in 2006, the market

for prescription drugs rebounded in 2007 (growth was about 25 percent) and is

on track to increase by more than 25 percent in 2008. The country is expected

to be one of the global top-five pharmaceutical markets by 2012, with annual

sales of US$48 billion (Exhibit 1). Several MNPs have stated that they aim to

reach US$1 billion in annual sales in China within the next few years.

However, several characteristics – not just its scale – combine to make the

Chinese pharmaceutical market challenging. It is extremely heterogeneous;

for example, access to physicians and hospitals varies markedly, as does

the availability of health insurance. Reliable data to track drug sales do not

always exist, and outside the major cities, distribution can be difficult. The

market is also changing rapidly. The government is mandating health-care

reforms, income levels are rising, and patients are taking a more active role

in treatment decisions. Furthermore, local pharmaceutical companies are

becoming increasingly sophisticated and more willing to compete directly with

MNPs.

3

Exhibit 1

Overall, market growth continues to be strong

48

25

12

2004 2008E 2012F

+13

+23

China pharmaceutical market*US$ billions**

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

Source: IMS; McKinsey analysis

• China will become a global top 5 pharma market

• 2nd largest market in terms of absolute growth in market size

• 2nd largest country in terms of sales force size for most MNPs

Over the next five years …

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As a result, the level of skill that enabled MNPs to succeed in China will

be insufficient to allow them to maintain their fast growth trajectory. More

sophisticated capabilities are necessary.

This is the second of two articles on what MNPs must do to succeed in China.

In our first article1, we discussed strategy – how these companies should think

about driving growth in the market and what choices they should consider

when it comes to their product portfolios, their approach to physicians and

patients, and their prioritization of territories. Here, we focus on the four core

capabilities that MNPs must have to execute their strategies successfully in

China: the ability to develop deep market insights, to ensure comprehensive

market access, to manage an expanding sales force effectively, and to

establish reliable channels for drug distribution and retail sales. We explain

why these core capabilities are so important in China and outline what MNPs

must do to acquire them.

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

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Market Insights

Most MNP executives in China know, in broad strokes, what factors are driving

the pharmaceutical market’s growth in China and their own performance here.

However, their companies often have only a superficial understanding of the

market’s dynamics, and thus many MNP executives have admitted to us that it

is difficult for them to set appropriate performance aspirations, to identify the

drivers of under- and over-performance, or to fully comprehend the market’s

competitive dynamics. They also find it hard to predict how the market will

evolve, given its uneven growth rate (Exhibit 2). As a result, these executives

are concerned that they will miss out on potential growth opportunities or be

caught by a sudden market slowdown. The inability to anticipate and quantify

the market’s drivers is becoming a much greater source of concern because

growth in China is becoming more visible – and more important – to their

corporate headquarters. Thus, MNPs must develop deeper insights into the

market here.

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

China – the market’s complexity and pace of change will reward companies

that can build a competitive advantage in this area. To develop superior

market-insight capabilities, MNPs in China should keep the following three key

principles in mind.

Exhibit 2

Year-on-year market growth is highly variable

Source: IMS; McKinsey analysis

2525

30

14

0

5

10

15

20

25

30

01 02 03 04 05 06 07 08E

CAGR=20%

China pharma market year-on-year growthPercentage

Anticorruption campaign

• Slowdown in real GDP growth

• Renewed anti-corruption drive

• Broader price controls

• Scope of essential drug policy implementation

Potential disruption factors

8

23 21

13

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Granularity

MNPs must start thinking at a much more granular level about the country

and the drivers of market growth here. China is not one monolithic market but

a set of sub-markets, each of which has different characteristics. Among the

factors that must be considered separately in each region are the prevalence

of specific diseases, the distribution of incomes (and how fast incomes

are rising), the percentage of the population with access to physicians and

hospitals, and the breadth and depth of medical insurance coverage. We have

seen clients alter their estimate of demand for a given drug by a factor of three

or four once they conducted a more granular assessment of these factors.

To think more granularly, MNP executives must start by asking the right

questions. For example: How fast will the new health-care policies promulgated

by the central government be implemented at city level? What impact will

community health centers have on patient flow for primary-care conditions?

What are the specific drug-class dynamics in China, and how do they differ

from global dynamics? What is the real competitive landscape (Exhibit 3)?

Exhibit 3

Proper market definition needed to understand real competitive dynamics

Source: IMS; McKinsey analysis

MNP definition of the market … … and the right definition

3034

4043 42

8 11 15 20 24

62

36

2004

55

40

05

45

43

06

37

61

07

34

73

2008E

MNP A

MNP B

MNP C

100% =

Company A gaining share against other MNPs

1331 38 43 50

8769 62 57 50

41

2004

57

05

70

06

106

07

147

2008E

MNPs

Locals

100% =

Locals – real winner of the game

%, US$ millions CNS EXAMPLE

Value share MNP market Value share total market

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trianGulation

In China, no source of information is sufficient by itself. MNP executives must

therefore apply their business judgment wisely while triangulating among

multiple sources of information if they want to generate real insights.

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

more developed countries, but it is nonetheless valuable. There are numerous

sources of quantitative data, including IMS (which monitors prescription data,

primarily in the urban markets) and the Ministry of Health’s hospital database

(which provides annual data on the consumption of Western drugs, among

other things). MNPs can also leverage their field forces to collect valuable

hospital-level data. There are two keys to getting good results from the data:

First, MNPs must invest up front by carefully structuring the research. Second,

they must remember that the absolute numbers reported may not be accurate

– but the trends generally are.

Ultimately, MNPs must find the right balance between “boiling the ocean”

(over-investing in attempts to get highly accurate data) and staying at a

somewhat superficial and deceptive level of market understanding.

institutionalization

In our experience, MNPs in China often generate useful market insights but

then fail to link them properly to business decisions. We believe that these

companies would be well served by increasing their investments in processes

that would allow them to fully capitalize on their market insights. For example,

an MNP could designate a specific function as responsible for the market-

insight generation process, institutionalize the analyses to be performed and

the sources of data to be obtained (to limit the impact of employee turnover),

and – most importantly – link all market insights to its strategic-planning and

brand-building efforts. Once these processes are in place, the company should

ensure that its market insights are refreshed on a regular basis.

On its own, the ability to generate good market insights is not sufficient to

ensure success in the Chinese pharmaceutical market. But it will be almost

impossible for MNPs to win in China without it, and if properly executed it can

become a source of competitive advantage.

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Market Access

Even the best market insights will be useless if market access restrictions

prevent uptake of a new drug. Often, even the best laid-out plans for

product uptake are hindered in China because companies have not invested

appropriately in ensuring broad market access. Establishing good market

access typically requires an MNP to surmount three hurdles: get the product

on China’s reimbursement drug list (RDL), convince individual hospitals

to include the drug on their formularies, and successfully negotiate the

tendering/bidding processes in each province. We discuss each of these

hurdles briefly below. MNPs should remember, however, that market access

is yet another area in which there are significant variations among provinces,

cities, and even hospitals; these variations must be monitored and managed

if a company wants to ensure good market access.

rEimbursEmEnt druG list

Although most health-care expenses in China continue to be paid for out

of pocket, the role of insurance is steadily gaining. Therefore, most drugs

benefit significantly – both directly and indirectly – by being included on

the RDL. For example, the drugs become reimbursable under China’s basic

medical insurance (BMI) program, which already covers 180 million people in

the country’s cities and is expected to include more than 250 million urban

residents by 2015 (Exhibit 4). Inclusion on the RDL significantly improves

Exhibit 4

Fast expansion of insurance coverage

Basic Medical Insurance for urban employees (BMI)

Urban Cooperative Medical Scheme (UCMS)

Insured population (millions)

180160

2006 2007

>250

2015F

50

10

2006 2007

>350

2015F

Source: MoH; MoHRSS; McKinsey | 3

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

of each drug’s cost. And because RDL-listed drugs are more affordable for

insured patients, hospitals and pharmacies are more likely to stock them.

Furthermore, because many Chinese physicians perceive inclusion on the RDL

as a stamp of approval from the government, they are more apt to prescribe

listed drugs, even to patients without BMI coverage. Thus, an RDL listing can

have a significant impact on a new drug’s trajectory in China (Exhibit 5). The

uptake of a new drug can be severely restricted by the lack of an RDL listing,

especially in drug classes with alternatives already on the RDL.

There is some debate around the importance of the RDL for newly launched

high-cost therapies (e.g., targeted antibody therapies for cancer). It is true that

many patients would be willing to pay out of pocket for these drugs. Our sense,

however, is that companies would still want to pursue an RDL listing for most

of them – the expanded size of the addressable patient pool would outweigh

the potential negative impact on price that comes with an RDL listing2.

Exhibit 5

Source: IMS

Sales volumeMillion units

RDL listing has been a critical driver of products’ uptake

71

5137

2512644

H1 H2 H1 H2 H1 H2 H1 H2

+44%

+56%

2004 2005 2006 2007

Arimidex(AstraZeneca)

5851

4332

24201815

H1 H2 H1 H2 H1 H2 H1 H2

+17%

+25%

2004 2005 2006 2007

Eloxatin(Sanofi-Aventis)

National RDL issuedRDL implemented in most provinces

231186170

117

54292923

H1 H2 H1 H2 H1 H2 H1 H2

+33%

+44%

2004 2005 2006 2007

Xeloda(Roche)

Sales growth signficantly accelerated upon RDL entry

ONCOLOGY EXAMPLE

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

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An even stronger argument in favor of RDL listing is that most new drugs enter

competitive markets; a company would face a long-term selling challenge if

it chose not to pursue an RDL listing for its drug but a competitor pursued

one for a similar product. Furthermore, the RDL’s importance may increase

in the next few years, because the new insurance program now being rolled

out for the remainder of the urban population, the Urban Cooperative Medical

Scheme (UCMS), may also use the RDL as the starting point for determining

which drugs to pay for.

Getting a drug on the RDL is not easy, however. Government policy suggests

that the list be updated every two years, but the actual gaps between updates

have been far longer. All drugs launched since the last update in 2004 must

wait for the next review, which is not expected until at least 2009. However,

the responsible government agencies have not yet laid out the processes that

will be used for the next review, which leaves open many questions around

eligibility criteria, review criteria, and the like.

Another complication is that the process for obtaining RDL inclusion is tiered.

The national review may be the most important part of the process, but each

province is allowed to add drugs to the list, and cities are also permitted to

influence its final composition. Thus, MNPs must build up their capabilities

at the national, provincial, and city levels to effectively manage the process

of getting their drugs on the RDL. It is particularly important that these

companies be skilled in three areas:

KOL management. The national and provincial reviews are strongly influenced

by recommendations from a small set of key opinion leaders (KOLs), some of

whom may not be among the opinion leaders that MNPs cultivate as part of

their normal sales/marketing efforts. Companies should therefore develop a

systematic map of the KOL networks in China and seek to identify the opinion

leaders who are likely to be part of the RDL review process. The companies

should also develop a clear value story (grounded in the Chinese market

context) for why their particular drug should be added to the RDL and then

disseminate that message to the KOLs.

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

and multi-tiered nature of the RDL process effectiveness at all levels, MNPs

must invest in building their government affairs organizations so that they can

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develop the experience, insights, and capacity to manage the process. During

the last review cycle, for example, several leading MNPs with good insights into

provincial dynamics were able to get many of their drugs onto some provincial

RDLs, even though they had missed the window for the national RDL.

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

putting increasing emphasis on China-specific clinical evidence, and thus

drugs that lack compelling local data to support their use are likely to be

at a disadvantage, especially when competing against drugs that have such

data. Furthermore, establishing local data provides a second advantage: it

helps expand physician usage, which is another important criterion in the

RDL review. Therefore, MNPs should make the need for local Chinese data an

important consideration in their early global clinical development processes

and also step up their post-market trial activity in China.

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

drugs. MNPs must therefore make sure that they put their best effort into the

application process, and leverage their cross-functional resources to enhance

the chances of success.

Hospital listinG

Getting on hospital formularies is an essential requirement for product uptake

in China – in the absence of a hospital listing, the likelihood that physicians

will prescribe a given drug is very small. Most hospitals have a set process for

deciding on formulary status (in most cases, a committee reviews new drugs

and decides which ones are approved). Unfortunately, though, the decisions

are still made on a hospital-by-hospital basis.

In the past, hospital listing was a relatively straightforward process that MNPs

could treat largely as a tactical exercise. This may be changing, though.

Government policy is now strongly encouraging hospitals to implement

new rules that limit formularies to two brands per molecule. Our recent

interviews with executives from more than 50 Chinese hospitals indicate

that many of them are beginning to implement this policy, although variations

in implementation will persist for the near term. We also found that most

hospitals implementing the new rules are approving one brand from an MNP

(usually the innovator) and another from a local company (usually a leading

branded-generic manufacturer). This is expected to lead to a decline in the

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

could well be favorable for MNPs, especially those that are able to maintain

their hospital listings. It is possible, however, that cost containment pressures

may prompt many hospitals to include only two lower-priced branded- generic

versions of a given molecule on their formularies, a move that would be

harmful to MNPs.

To mitigate this risk and maximize the likelihood that their drugs remain on

hospital formularies, MNPs will need to become more vigilant about managing

their relationships with hospitals. They should therefore revisit their efforts

on education, not just for physicians but also for the other participants in the

decision-making process (e.g., pharmacists). It may also make sense for these

companies to explore broader partnerships with hospitals (e.g., by sponsoring

hospital-based screening programs or patient-access programs) so that they

can establish the value proposition for their drugs and differentiate them from

the other brands or molecules competing for formulary approval.

tEndErinG/biddinG

Getting a drug on the RDL and on hospital formularies is not sufficient for

gaining market access in China. The drug must also be stocked in pharmacies

– particularly hospital pharmacies, which dispense over 85 percent of all

prescription drugs sold in China. Provincial and city tenders are playing an

increasingly large role in the procurement process for the hospital pharmacies

in their regions.

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

subject to tight volume controls. MNPs may therefore be tempted to bid

low on some tenders to ensure market access, but this approach can have

unexpected consequences. Many Chinese provinces are starting to use

reference pricing, and so the outcome of a tender in one province can have

cascading effects in other parts of the country. We therefore recommend

that MNPs think strategically about the tendering/bidding process and then

develop appropriate tactics to ensure that they can balance the need for

market access against the need for effective pricing.

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

process is convoluted and opaque, and often seems like a black box to anyone

not directly involved in it. Given the growing importance of provincial and city

tenders, however, it is necessary that MNPs develop the ability to assess each

tender individually to determine the right price to bid. Equally importantly, the

companies must have clear guidelines for when it is appropriate to walk away

from a tender.

Successfully navigating the tendering/bidding process requires a cross-

functional effort with involvement from sales, commercial (with the support

of distributors), and the government affairs team. The marketing department

is also often involved to help prepare the detailed product information that is

required in certain tenders to justify the product’s inclusion.

In particular, MNPs should make sure that their government affairs organizations

have the resources available to understand the dynamics within each province

and city. For example, some provinces and cities are much more concerned

with cost containment than others are. The provinces and cities also vary

considerably in the extent to which they are influenced by local pharmaceutical

companies (particularly if those companies have headquarters or manufacturing

facilities in the area). We have repeatedly seen that MNPs that submit a bid

without a clear sense of those dynamics are rarely successful in getting the

pricing they want.

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

plan at the provincial and city level. The plan should help a company

communicate the value of its drugs and the investment it is making in

improving the quality of and access to care in China.

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Sales-Force expansion and management

Although the pharmaceutical industry has ended its long “arms race” in

the U.S., it appears that China has become the new battleground for the

industry’s field forces. Between 2003 and 2007, the top 12 MNPs added an

estimated 8,000 sales reps in China, and their combined number now totals

over 12,000. For many leading companies, China will soon have the second-

highest number of sales reps after the U.S. At most MNPs, the return (in

terms of increased sales) is directly proportional to the number of FTEs added

(Exhibit 6). We have calculated, however, that the top MNPs will collectively

need to hire an additional 12,000 to 18,000 reps in China between now and

2012 if they are to meet their stated growth aspirations (Exhibit 7).

These companies must scale up their sales forces so that they go deeper

and expand more broadly in the China market. Most leading MNPs have

plans to detail a greater number of physicians within the hospitals they are

already targeting – they want to reach more junior physicians within currently

targeted departments and expand the number of departments visited in a

given hospital. Furthermore, most of these companies still have a lot of ground

to cover in terms of both new hospitals in currently targeted cities and new

cities with attractive market potential. Even the biggest MNPs have largely

concentrated their sales forces in China’s leading class III hospitals and its

top 100 cities3. But footprint expansion is becoming increasingly important for

them as the country’s economy grows, insurance coverage increases, and the

government intensifies its efforts to encourage patients to be treated in class

I and II hospitals and community health centers.

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

however. In comparison with 10 years ago, it is now much more difficult to

recruit graduates from leading medical schools or to hire doctors from big

hospitals. Furthermore, hiring salespeople away from local pharmaceutical

companies presents risks: The local companies often use “push” models that

incentivize physicians financially to prescribe their drugs, and getting these

reps to adopt a sales model based on the scientific evidence for a drug can be

difficult. Furthermore, the local companies are also in great need of additional

sales reps, and many of them are trying to transition to a more scientific

business model; thus, they will increasingly be competing with the MNPs for

the same talent pool.

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

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Exhibit 6

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5

MNC 1

MNC 2

MNC 3

MNC 4

MNC 5

MNC 6

MNC 7MNC 8

Fold increase in sales FTE 2002-07

Fold increase in sales 2002-07

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

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

Exhibit 7

Significant field force expansion expected to support high growth aspirations

* Prescription drugs only; ex-manufacturer value** Assumes constant exchange rate over the period

*** Current average productivity of US$290,000 per repSource: McKinsey analysis

High growth aspirations ...

Cumulative revenue of top 12 MNPs*US$ billions**

8.6

3.5

2.0

2005 2007 2012

~32%CAGR

~20%CAGR

... imply significant field force ramp-up

• At current productivity levels*** 18,000

• Assuming 25 percent increase in productivity from current levels 12,000

Incremental sales reps needed

• 1,000-1,500 new reps by company • Compounded by high industry turnover

of 24%• Gains in productivity imperative to

sustain model

ESTIMATE

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China’s high employee turnover rates exacerbate the need for additional reps.

In the aggregate, MNPs have a 24 percent annual turnover rate here; even

the best companies have a 15 percent rate. As a result, the average MNP

sales rep has only two years’ experience in the job, and most companies

must change rep assignments frequently, making it difficult for the reps to

build strong relationships with doctors. At some MNPs, nearly 40 percent of

physician-rep assignments are changed each year.

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

Within a few years, the MNPs competing for market leadership in China will

be managing field forces with more than 3,000 reps, covering thousands of

hospitals in hundreds of cities over a vast geography.

Given these realities, what should MNPs that want to succeed in China do? To

answer this question, the companies must consider two related issues: how

they can maximize the return on their sales-force investments, and how they

can differentiate themselves in the market. There are four areas outside the

day-to-day realities of sales-force management that MNPs can explore:

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

dramatically improve, given the talent situation. Therefore, MNPs should

invest in developing recruiting and training engines that are sized for the

market’s scale and complexity. To succeed, these companies must be able

to recruit and train a large number of reps and managers every year, so they

need a streamlined approach for identifying, cultivating, and instructing new

employees. Some MNPs have recognized this need and have adopted new

approaches. For example, a few companies have created formal “sales-force

universities” that can help meet their exploding training needs. MNPs must

go further, however. They must expand the profile they typically use to identify

candidates for rep and manager positions – just tapping the same pool for

additional reps is becoming increasingly untenable.

Productivity. In the recent past, given the country’s very fast growth rates,

many companies have paid scant attention to how they could improve sales

productivity. However, MNPs must crack the code of sales-force productivity

in China. They must start thinking more deeply about hospital and physician

segmentation, the effectiveness of all calls/details, and how they can better

align their resources against market potential. Although most MNPs have

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

simplified and tailored for implementation in China, for several reasons. As we

mentioned, companies in China often lack the types of detailed data required

to implement the sophisticated segmentation approaches that work in more

developed markets. And because the average tenure of most reps in China is

so low, they lack the skills needed to utilize complex segmentation approaches

in the field. In addition, the Chinese market is highly tiered, and there are

significant variations across cities and across hospitals within cities.

Value proposition. MNPs should develop a better value proposition for their

sales reps, and in particular for their front-line sales managers. Given

China’s scale, the front-line managers must be the glue that holds the sales

organization together. At present, most MNPs have simply copied the value

proposition they used globally, which is primarily based on compensation.

Successful employers in China are beginning to offer rewards that go beyond

compensation to retain their best people; these rewards can include more

regional/global exposure, executive education, and other indirect financial and

career-building incentives.

Alternative models/approaches. MNPs should continue to explore alternative

sales-force models and approaches. China’s size offers companies a large

canvas for innovation and ample opportunity to experiment. MNPs should put

in place methods for systematically piloting new ideas, such as the use of a

phone-based sales force for lower-tier cities or part-time reps for lower-class

hospitals.

In China, the competition for talent affects all industries, not just pharmaceuticals

– and all business functions, not just sales. But given the size of MNP field

forces, finding and retaining sales reps – and maximizing the productivity of

the sales force – will be top of mind for general managers for years to come.

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Distribution and retail channel management

Even the best field force will be ineffective if a company cannot get its drugs

to hospitals and pharmacies, and distribution remains a significant challenge

in China. Thus, MNPs must develop both short- and long-term strategies for

working with drug distributors. Furthermore, they must not ignore the retail

pharmacy channel. Although this channel accounts for less than 15 percent of

all prescription drug sales in China, it presents specific opportunities, as well

as several risks that must be managed carefully.

druG distributors

In China, drug distribution is highly fragmented. There are more than 10,000

distributors, and the top 10 companies combined have only a 34 percent

market share. The vast majority of distributors operate in only one or a few

cities; they rely on their relationships with local hospitals for sales. As a result,

the supply chain is convoluted; drugs may pass through multiple hands before

reaching hospitals and pharmacies (Exhibit 8). For this reason, many senior

pharmaceutical executives in China view their supply chain as another black

hole – they may know who their level 1 and 2 drug distributors4 are, but they

have little insight into what happens to their products beyond that.

Exhibit 8

Multi-tier, fragmented distribution system

Source: SFDA; MoH: Interviews; McKinsey analysis

• ~20,000 hospitals

• 200,000 + retail pharmacies

Inde-pendent ChainClass

IIIClass

IIClass

ICommunity

health centers

Level 2 distributors

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

Level 3 distributors

~10,000 distributors

Manufacturers

Retail pharmaciesHospitals

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Fortunately, there are some signs that the industry is consolidating, although

the speed of change is slow (Exhibit 9). For example, several leading

companies are building regional coverage through mergers and acquisitions5.

Furthermore, a number of small distributors have exited the market because

of accounts receivable problems, difficulties in obtaining GSP (good supply

practice) certification, and the repeated price cuts that have squeezed – and

in some cases eliminated – their margins.

In the short term, MNPs should accept the fact that they must have sizable

distribution networks if they want to pursue broad geographic coverage. We

recommend that MNPs begin by selecting 10 to 30 Level 1 distributors to

work with. Among the factors that should be evaluated are each company’s

scale, network, geographic coverage, logistical capabilities, hospital access,

Exhibit 9

There are signs of gradual distributor consolidation

Market share of distributors*

41 38 32 32

33 3636 34

26

2001

26

2003

31

2005

34

2007

Top 10distributors

Top 11-100distributors

Others

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

McKinsey analysis

Number of distributors

~16,000 ~10,000

4 China’s drug distributors are grouped into three levels. Companies in the first level have national or regional distribution capabilities. Often, however, they must subcontract work out to smaller companies to ensure that they can distribute drugs to smaller or more remote cities. Level 2 distributors have narrower capabilities, although they can often reach multiple cities. Level 3 distributors (the majority of companies) have very limited distribution capabilities, often restricted to no more than a few cities.

5 For example, Sinopharm has started to build regional coverage in Guangdong province through its acquisition of Accord Pharmaceutical Co.

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

more remote cities, they will also need to work with a large number (typically,

100 to 1,000) of level 2 and 3 distributors.

Of course, MNPs must have strong distributor management capabilities to

cope with such a sizable network effectively and ensure channel transparency

and stability. Many of them will have to develop systems, processes, and

in-house resources to collect drug sales data from as many distributors as

possible in a timely and accurate manner. But even if they are successful

in doing this, they must accept that in the short term it may not always be

possible to match the sales volume sold to distributors with the volumes

reported from end customers.

However, MNPs can derive benefits (beyond logistics) from this large network

by leveraging the value-added services distributors can offer. With their local

contacts and resources, for example, distributors can serve as valuable

partners to MNPs by providing assistance with the drug tendering and hospital

listing processes, as well as important business intelligence about the

markets they serve.

Over a longer time frame, MNPs may be able to leverage certain of their

distributors to penetrate some of China’s wealthier lower-tier cities6 and rural

areas. Many companies see these cities and areas as a long-term opportunity,

particularly for their mature products and inexpensive therapies, but they

currently have no way to exploit it cost effectively. MNPs should remember,

however, that they cannot simply outsource the sales effort for prescription

drugs to distributors. A crucial part of generating demand is building doctors’

knowledge about them, and few distributors have the capabilities to provide

scientific information to doctors. An MNP could solve this problem by

collaborating with a few distributors that are both credible and interested in

expanding. For example, the MNP and its qualified distributors could adopt

the “shadow management” approach widely used in the fast-moving consumer

goods industry. Under this approach, the MNP would provide support as

the distributors set up sales teams to promote drugs. The MNP would offer

training and incentives to the distributors’ salespeople, and it would also

closely manage their daily work.

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

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rEtail pHarmaciEs

At present, total retail pharmacy sales in China are estimated to be about

US$16 billion; over-the-counter medications and traditional Chinese medicine

account for more than 70 percent of this spending. Less than 15 percent of

total prescription drug sales are sold through the retail pharmacy channel,

and this is unlikely to change significantly in the near term (Exhibit 10).

Chinese hospitals derive a significant portion of their income and profit from

their pharmacies, and so the separation of drug prescribing and dispensing is

unlikely to happen unless significant changes are made to the funding model

for hospitals. Furthermore, China’s new community health centers, which

are being set up rapidly and which provide convenient access to prescription

refills, pose increasing competition to retail pharmacies.

Exhibit 10

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

13.5

11.610.0

8.87.5

2002 03 04 05 06

20%

TCM

Non-medicalmerchandise

+17%

40%

30%

10%

16.2

2007

Rx

OTC

Retail pharmacy sales*(US$ billons

* At retail priceSource:China Southern Medicine Institute of Economics; interviews; literature search; team analysis

This represents <15% of total Rx sales

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Nevertheless, MNPs should not ignore the retail pharmacy channel, for at least

three reasons. First, the importance of this channel to a specific prescription

drug can vary widely, depending on the product’s pricing, indication, and life-

cycle stage. For example, up to 30 percent of the revenue for some mature

brands can come from retail pharmacies. Also, there is large geographic

variation; the retail channel presents a fairly significant share of prescription

drug sales in some Chinese cities, such as Harbin. Second, the risk of

product stock-outs and generic substitution at retail pharmacies is high. A

new government policy mandates that prescriptions be written with only a

drug’s chemical name, which makes it easier for pharmacies to substitute

generic versions. Third, prices at retail pharmacies, which are typically lower

than those charged by hospital pharmacies, are sometimes used as reference

prices by the provinces and cities; price erosion can be significant unless retail

channel prices are managed carefully.

MNPs can take steps to strengthen their retail channel management skills

and thereby capture the opportunities for certain products/geographies and

minimize the downside risks. For example, they can establish a key account

management team to work with China’s top retail pharmacy chains; this will

help ensure that they have broad coverage for their drugs, that no stock-outs

occur, and that pricing levels are maintained. In addition, they can provide

training to pharmacists at key stores to reduce the likelihood of generic

substitution.

Given the challenges we have outlined, drug distribution may be the core

capability that takes the longest for MNPs in China to master. But it is crucial

for their long-term success in China.

* * * * *

To win in China, MNPs must have both a solid strategy to drive growth and

the core capabilities to execute against that strategy. These capabilities

include the ability to develop deep market insights, to ensure broad market

access, to drive productivity from an expanding sales force, and to establish

reliable channels for drug distribution. Our experience has convinced us that

strong execution will be the biggest factor determining which MNPs do best

in China.

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Contributers

Franck Le Deu is a Principal in the Shanghai office

[email protected]

Rajesh Parekh is a Principal in the Shanghai office

[email protected]

Jin Wang is an Associate Principal in the Shanghai office

[email protected]

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