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China Cracks Down on Foreign Pharmaceutical Companies for Price Fixing

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A storm is brewing in China, as the country has begun a series of crackdowns on various industries for offenses ranging from bribery to price fixing. The storm has broken most recently over the heads of pharmaceutical company executives, with Britain’s GlaxoSmithKline being accused by Chinese authorities of bribing physicians and officials to increase sales and fix the prices of drugs and other firms being investigated.

At first denying any wrongdoing, saying that it had conducted an internal investigation that revealed no bribery and fraud in its operations, GSK later admitted that its executives in China may have broken the country’s laws. GSX CEO Andrew Witty sent three of the firm’s top officials to China to meet with its government, and Mark Reilly, British head of the firm’s Chinese operations, returned to GSK’s London offices in early July. Toward the end of the month, the company announced that he would be replaced as general manager in China by Herve Gisserot, senior vice president for Europe.

While it is by no means the only pharma company in the hot seat, GSK has been the focus of an investigation that led Chinese officials to raid offices and detain personnel as they looked into allegations of bribery, price fixing and tax evasion. As the investigation proceeded, other companies including Roche and Merck have admitted using a small Shanghai travel agency that police said was a means for GSK to provide bribes to the hospitals, doctors and government officials involved in the scandal. Britain’s AstraZenica has also said that one employee had been questioned by Shanghai police, and that two others had been detained. Brussels-based UCB SA was also paid a visit by authorities.

The success of bribery and price fixing as a means of boosting revenue can be tied to, among other factors, the low salaries of doctors and other medical personnel in the country and the fact that hospitals derive 40% of revenue from the prescribing of drugs. China’s official news agency has said that more pharma companies could be investigated as the government’s six-month-long drug crackdown advances, encompassing not just pharma companies but also illegal drug sales online and counterfeit traditional Chinese medicines.

China’s crackdown on the pharmaceutical industry could end up saving it a great deal of money, since, according to the World Health Organization, medicines account for some 43% of the total that China spends on health care. Another factor to consider is the growth of health care coverage in China, which, according to a recent McKinsey report, rose from 43% in 2006 to 95% in 2011; total government spending on health care was expected to rise from $357 billion in 2011 to $1 trillion by 2020.

Officials have already said they are looking into the pricing practices of perhaps as many as 60 drug companies, both Chinese and foreign. With such a massive market at stake, China’s crackdown has a dual purpose: to cut its costs and also to push domestic companies into competition with global pharmaceutical firms. Foreign pharma companies are pursuing market share in a country that is expected to come in second only to Japan in size as a market for pharmaceuticals in just a few years, and where foreign drugs, despite their higher prices, are popular because of fears of contamination and poor quality of domestically produced medications.

But that may not be the case for long, because China has been working on its own biomedical industry—investing a cumulative total, according to Lux Research, of $160 billion in the quest to transition from predominantly manufacturing to research and development as well, with an eye toward eventual export markets.

Investors watching the headlines have likely already heard that GSK warned in its second quarter results report that the Chinese investigation will hurt its bottom line. While CEO Witty said that it was too soon to know how much of an effect the reputation damage and possible wrongdoing would have been small, Morningstar analyst Damien Conover said.

GSK’s sales to China made up 3.2% of Q2 figures for the group, up 14% for the quarter. While Conover said that China is “important and a fast-growing area” for the company, and for other pharma companies whose sales in the region are in the same range, he echoed Witty in saying that it was too early to tell how much GSK in particular and the pharma sector in general could be affected by the investigations and allegations. Conover added that if GSK were indeed guilty of “egregious actions,” it “would have some minor valuation implications.” In addition, while there could also be fallout from the companies’ own domicile governments or even from the EU for illegal activities, “it is really too early to say.”

Britta Holt, analyst at Fitch, asked about possible ramifications, said that presence in the China market “is essential for future growth and expected to remain high on the agenda of each of the big pharma companies. The current situation is not likely to change this.”

That’s good news for investors, although much depends on how determined China is to pursue the situation regarding both foreign and domestic firms—and not just in pharmaceuticals. The country has announced other crackdowns in addition to its actions in the pharma industry. Price fixing charges have been leveled at imported infant formula (think Nestle, Danone and Abbott) and for jewelry shops (the largest in the world by market value, Hong Kong-based Chow Tai Fook Jewelry Group, is under investigation, along with others, by China’s National Development and Reform Commission), and at the end of July China’s official Xinhua News Agency called for an investigation into price fixing and “profiteering” in the imported luxury automobile market.