China is changing the way it procures drugs. The result: Prices are tumbling and eroding the once-high margins of drugmakers -- both local and foreign -- in the world’s second-largest pharmaceuticals market. For manufacturers, the pressure on prices is set to intensify.

1. What exactly is China doing?

In September, China asked drugmakers to submit bids to supply 25 commonly used generic drugs to hospitals across the country. The move followed a pilot program in 11 major cities -- including Beijing, Shanghai and Guangzhou -- that saw pharmaceutical firms bid for supply contracts for medications including allergy and high-blood pressure treatments and cholesterol and cancer drugs. While the pilot, announced in December, picked just one company for each of the drugs in those 11 cities, the nationwide program will name as many as three.

2. Why’s China doing this?

The government is overhauling its healthcare system to provide better access to quality drugs and treatment for its population. It’s already importing more foreign drugs and making more of them reimbursable through its national insurance plan, but it also wants to contain costs. Since its greatest bargaining chip is the sheer volume of demand from its massive population, China is consolidating procurement to glean the best prices. The pilot plan saved as much as 5.8 billion yuan ($816 million).

3. So this is bad news for pharmaceutical companies?

Not entirely. Both Chinese and multinational companies oppose the plan because it will inevitably slash drug prices and hurt their bottom lines. Still, by allowing up to three suppliers for each drug, the Beijing government has at least addressed a key objection: That limiting the supply of a drug to a single company puts patients at risk from disruption to its supply chain and any quality issues. The majority of Chinese drugmakers rely on cheap production of generic medications to drive revenue, which means their profit margins are already slimmer than global rivals that also invest in research and development. Nearly 70% of the 65 China-listed drugmakers have flagged slower profit growth citing, among other reasons, the procurement plan.

4. What about the multinationals?

Global drugmakers are less affected because they also can count on their pipeline of novel drugs, which are still protected by patents. In a Chinese market quirk, foreign pharmaceuticals still do plenty of business with Chinese hospitals on their blockbuster drugs, such as Pfizer Inc.’s cholesterol medication Lipitor, even though the patents for such drugs have elapsed. According to Bocom International analysts, Pfizer supplied 74% of Atorvastatin, the generic name for Lipitor, to hospitals in China prior to the bidding, even though Chinese generics exist. It was a similar story for Pfizer’s blood pressure medication Amlodipine (84% of supply to hospitals) and Novartis AG’s cancer treatment Imatinib (81%). Those numbers stand to take a hit should cheaper local rivals win the nationwide contracts. AstraZeneca Plc says sales in China will slow in the second half of 2019 due to the new program.

5. Is there anything positive for Big Pharma?

It’s not all bad news. The Chinese government also has reformed its drug approval process, allowing multinationals’ novel treatments into the country at a rapid pace -- sometimes faster than in the U.S. AstraZeneca expects new and innovative treatments to contribute 60% of its China revenue by 2024, up from just a fraction currently, as it pivots away from the generics business.

To contact Bloomberg News staff for this story: Rachel Chang in Shanghai at wchang98@bloomberg.net

To contact the editors responsible for this story: Rachel Chang at wchang98@bloomberg.net, Grant Clark, Bhuma Shrivastava

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