Developing World Healthcare Blog

Opening of E-commerce Drug Channel to Change China’s Market

As discussed in last month’s post, numerous press outlets report that China’s Food & Drug Administration (CFDA) will release regulations permitting online sales of pharmaceuticals soon. This action should help the Chinese government in its efforts to lower drug costs for its citizens by:

  1. Creating a lower-cost channel to undercut the current multi-tier distribution channel that serves state hospitals (70% of the market);
  2. Addressing the current shortage of pharmacists (China: 1.47/10,000 population; Global average: 6.02) through creation of larger dispensing platforms that increase productivity; and
  3. Providing a more efficient channel for retail pharmacies to compete with hospital-based pharmacies.

According to the December issue of Pharma China, the regulation will include a list of drugs permitted for internet sales. Industry analysts expect the list to include:

  1. oral drugs for chronic conditions;
  2. new drugs that haven’t participated in the China’s tender process;
  3. drugs “involving privacy;” and
  4. generic drugs with high “price/efficacy” advantages.

Structure of the Chinese Drug Distribution Market

China’s healthcare industry suffers from an inefficient drug distribution system. Manufacturers ship product to a national distributor that will sell the product to end customers (hospitals and pharmacies) OR to provincial/local distributors who will then sell the product to pharmacies and hospitals. In some cases a drug will go through several layers of distributors before reaching the end customer. Each layer of distribution adds a markup to the product’s price (some of which funds “hongbao”).

According to a presentation by Haojia, an online drug distribution start-up, the direct distribution channel represents 57% of China’s RMB1,304bn (US$208bn) drug market. The multi-layer (or “indirect”) channel represents the remaining 43%. Retail pharmacy sales are RMB260.7bn (US$42bn), and the online business-to-consumer component of RMB4.3bn (US$799m) is only 1.6% of this amount. Online drug sales (largely healthcare products such as contraceptives) represent RMB400m (US$64m) of this amount.

The Online Opportunity is Drawing a Crowd

CFDA has licensed 366 pharmacies for online dispensing as of Dec 2014. Four online companies have received licenses for business-to-consumer sales: Alibaba (Tmall), JD.com (Jingdong), Wal-Mart (Yihaodian), and 800pharm.com. Alibaba is the leader with a 40% share. In addition, 270 drug stores have received licenses: 60% of them are using one of these platforms. Leading distributors such as Sinopharm, Shanghai Pharmaceuticals, and Jointown Pharmaceutical Group have established their own e-commerce sites (source: Securities Times) that focus on the business-to-business segment.

Guangzhou Baiyunshan (also one of the leading distributors) is raising US$1.6bn for various corporate purposes, including development of an online pharmacy in conjunction with Alibaba Health. Yunfeng (Alibaba founder Jack Ma’s private equity fund) is a modest investor in the offering. Among retail chains, China Nepstar Chain Drugstore sells products through its Website star365.com and Tmall. Jintian Pharmaceutical Group and China JoJo Drugstores also use Tmall. Tianjin SKF (GSK) is the first multi-national drug company to open an online store, offering the company’s consumer healthcare products and, ultimately, prescription products. Other MNCs will follow suit.

Potential Evolution of the Online Segment

Current penetration of online sales is very low. Some observers attribute this to the newness of the concept, and customers’ inability to wait 1-2 days for delivery. The first issue should self-correct with time. The latter issue will require coordination between online and retail pharmacies. (Note: the US model is dispensing the initial 30-day supply at retail with subsequent fills via the mail/online channel.) We should mention that drug consumption increases exponentially with age, and the key to success will be changing the behavior of the elderly.

Some observers expect online prices to be 5-10% lower than hospital and retail outlet, but this assumes that the online providers will possess the scale to purchase drugs at competitive prices. We do not think this will be the case initially.

Important Differences between the Chinese and US Models

Many commentators highlight the potential for China’s online market by pointing to the US market’s 30% penetration. As with most subjects, the US context differs from China. US Health insurance plan designs have been the main driver of online penetration. Health plans (mainly at the behest of their employer clients) have used a variety of tools such as mandatory mail dispensing; default mail dispensing; and out-of-pocket differentials to drive this channel’s growth. In China, Shanghai and Hainan have tested direct Basic Medical Insurance (BMI) reimbursement for drugs purchased at online sites. The availability of direct reimbursement can play a major role here. Implementing this feature nationally likely will take at least 1-2 years.

Winners and Losers: Initial Thoughts

This policy change’s impact is difficult to assess absent the regulations. At first blush, the regional and local distributors are at risk of extinction. Retail pharmacies should benefit from the migration of business out of hospital-based pharmacies, but face the risk of price competition. The leading distributors face a similar dynamic: squeezing out the smaller players while contending with margin pressures. The pure-play online providers look like clear winners because any business will be incremental.  Their major challenge will be scaling up to meet demand, which won’t be quick or easy.

Questions to Consider as the Process Unfolds:

  1. How to coordinate the handoff between initial prescription and refills?
  2. Will the dominant model be shipping to a pharmacy for pickup or to the home?
  3. How quickly can online platforms develop the scale to provide competitive direct dispensing to people’s homes? Can the postal system handle this?
  4. Will the regulations allow or encourage 90-day dispensing?
  5. How will hospitals respond to these changes (compete with retail pharmacies or cede the business)? 

The author owns shares of China Nepstar Chain Drugstore.