Q&A: China Problem For Pharma Stocks

Over the past few weeks, the bribery scandal in China that is enveloping GlaxoSmithkline has caused a stir. The episode comes less than a year after the drugmaker paid $3 billion to settle civil and criminal charges for marketing drugs for unapproved uses and withholding clinical trial data, among other things. This prompted Glaxo ceo Andrew Witty to vow to upgrade operations to restore integrity, which underscores the embarrassment the scandal is causing Glaxo (GSK).

Penetrating China, India and other developing economies is one of the factors to turning around sales declines at major drug makers, including Glaxo, Pfizer (PFE), Merck (MRK), Sanofi (SNY), Eli Lilly (LLY) and AstraZeneca (AZN).

GSK Revenue TTM Chart

GSK Revenue TTM data by YCharts

Beyond Glaxo, though, the issue is reverberating among its many rivals, who have also scrambled to do expand in China. But Chinese authorities are now turning their attention toward other global drugmakers. We spoke with Ted Acosta, global in the life sciences practice for fraud investigation and disputes at Ernst & Young. We want to note that our conversation took place immediately before the firm, which already counted Glaxo among its clients, was retained specifically to review Glaxo operations in China. This is an excerpt…

Pharmalot: So how did we get to this point? There are cultural issues, of course, (but) how rampant is this sort of corruption we’ve been seeing?

Acosta: My experience in working in China… this is an issue that life sciences companies have been struggling with for quite some time, particularly the multi-national companies… Business there is still developing in terms of how much growth companies can have compared with Chinese medicine…. Western medicine is still a foreign concept in some parts of the country and they need to engage in a lot of education and promotion and outreach, in the same manner as in in the Western world, but more basic – so there’s more effort to get more doctors and hospitals to understand about where they’re coming from and the benefits of Western science; having said that, the country is catching up rapidly.

At the same time, it’s a culture that hinges a lot on personal relationships… The facts about products and services are sometimes as important as relationships with the purveyor of products and services… They’re starting to move away from relationships, but it’s so ingrained that it’s difficult to separate and will be a slow process. There’s nothing nefarious about that, but when you combine this with the need to sell products and the notion of quid pro quo, you can be misunderstood by locals, who are measured by how much product they sell and compensated by volume of what they sell. When you put all those things together, you get an environment that exacerbates this situation where you can have an emphasis on relationships… And I think it’s at the core of a lot of these issues… They have budgets and cash on hand and tools to put to work to help in building these relationships.

That isn’t to say there aren’t unscrupulous people who will abuse the system and disregard the rules. Multinationals are certainly exerting efforts to develop compliance programs and education to get everyone on the same page. So no matter what your own cultural traditions are in terms of gifting and developing relationships, their employees know that inappropriate business practices won’t be tolerated.

Compliance efforts by multinationals have been going on for eight or nine years, particularly in China. But many incentives haven’t changed – the locals are still measured by how much they sell; there are sales quotas. And they’re instructed to engage in all types of typical promotional activities – the time spent with clients, the doctors and hospitals… So the potential for abuse and potential to avoid the rules is still there, especially when local operations are given means to engage in all sorts of promotional activities.

Pharmalot: Chinese authorities have been investing tremendously in their own domestic pharma industry. To what extent might these probes be used to bolster those companies at the expense of the multi-nationals?

Acosta: There’s a possibility if certain multi-national companies are discredited by virtue of allegations or investigations or news stories that are unbecoming that it could have a chilling effect on doctors and hospitals dealing with these companies and changing their preferences toward dealing with local companies. But there aren’t that many local companies that compete right now with the multi-national companies in terms of the portfolio of products. What the multi-national companies bring is significantly more mature and advanced. Chinese companies have more focus on generics and Chinese medicine and some distribution, although again, they are advancing rapidly. Yes, the cynical view is if you discredit multi-national companies in general, it may leave a gap for local companies to fill… But we don’t expect that to be the case. The next big frontier, in fact, is for Chinese companies to show the same level of ethics and transparency as the multi-national companies been seeking in their global operations.

Pharmalot: What about the notion of using these probes to lower health care costs, which is another area that’s being investigated?

Acosta: It is possible the Chinese are looking at it in this manner… the use of branded products are expensive… But my experience is that, ultimately, like in Europe, the government holds the card on pricing because they’re the biggest purchaser. And whether they do it by legislation or cutting back on (purchasing) branded products, I think they have a much greater opportunity to obtain lower prices through those methods. It’s not like in the US with many private payers. But no one has made the case that prices will come down as the result of (this kind of) enforcement. To the extent there is competition, even if you eliminate any perceived corruption, you still have competition.

Pharmalot: So why now then?

Acosta: I recall a series of very active investigations of multi-national companies happening over the last five years. I haven’t seen a single year that has gone by without a number of investigations. One thing to caution is that recent one might just be getting more attention than those before. The difference is they’re detaining multi-national employees at high levels. And that’s new and very concerning. Although we have heard the Chinese government is very concerned about corruption, in general, and there were some highly publicized case of graft in the government and they’ve gone after popular, promising political figures, the government has been announcing they would take more steps to ferret out corruption, which in time, would include going after foreign multi-national companies. They didn’t single out any industry, but obviously life sciences has a lot of exposure because a majority of business is obtained through government entities and touch points are much more numerous than with other industries. It was a matter of time before we saw this kind of attention.

To read the remainder of this article, go to Pharmalot.

Ed Silverman, a contributing editor of YCharts, is the founder and editor of Pharmalot. He previously reported on the pharmaceutical industry and other business topics for the Star-Ledger of New Jersey, New York Newsday and Investor’s Business Daily. He can be reached at editor@ycharts.com. You can also request a demonstration of YCharts Platinum.



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